The contraction in the credit markets two years ago and the subsequent crisis at major financial institutions caused the M&A deal landscape to change significantly. On the whole, there has been a renewed emphasis on risk allocation, with sellers stressing deal certainty and buyers focused on managing business deterioration and financing risk.

Prior to the credit crunch, financial buyers often arranged to buy businesses in deals that required a termination fee to be paid by the sponsor if the shell-company buyer refused to consummate the transaction. These reverse termination fees evolved out of seller demands for sponsors to eliminate traditional financing conditions and add more "skin-in-the-game." Commonly, the fee was payable if the buyer failed to close not just because of a financing failure, but for any reason (including intentional breach). The price of this "option" was typically the same as the breakup fee paid by a seller following a successful topping bid (about 2% to 4% of the equity value). The payment of the fee was often intended to be the "sole and exclusive" remedy for a breach by the buyer, and recourse to the sponsor was expressly limited to payment of the fee.

As the credit markets tightened, sellers and financial buyers had to adapt. As a result, in the significantly reduced number of financial sponsor deals announced post-Lehman, many omitted debt financing altogether, purchasing businesses with 100% sponsor equity.

With less debt financing involved, the number of deals employing a reverse termination fee structure declined significantly. Through the third quarter of this year, only 38% of public company financial sponsor deals contained reverse termination fees, compared with 81% at the height of the leveraged buyout boom.

In financial sponsor deals that required debt financing, financing "outs" have not become commonplace, indicating that sellers remain reluctant to take full financing risk. Most likely, buyers were agreeing to greater market-flex provisions in debt commitments -- giving lenders greater ability to unilaterally change the terms of the debt financing -- in order to secure the financing commitments sellers were requiring. Buyers were likely reflecting this increased risk of borrowing cost in their deal prices. Sellers who needed to sell to leveraged purchasers were seemingly willing to negotiate on price in exchange for increased deal certainty.

The tight credit markets have, however, resulted in an increasing use of the reverse termination fee model in leveraged acquisitions by strategic buyers, but modified to reflect some hard lessons learned from the failed leveraged buyouts of the past two years. Unlike many of the LBO deals, where reverse termination fees were effectively pure walk-away options, payment of a reverse termination fee in the strategic deals announced post-Lehman has generally been tied to a financing failure. Strategic buyers in Pfizer-Wyeth, Merck-Schering-Plough, Warner Chilcott-Procter & Gamble and Xerox-ACS were able to negotiate the ability to walk away if financing did not come through, albeit for a higher price (about 3% to 7% of transaction value) than the typical financial sponsor termination fees during the LBO boom. The sellers in these deals were willing to accept the fee as their "sole and exclusive" remedy only if financing failed. Buyers remained on the hook, however, if financing was available and other conditions were met.

Buyers and sellers have also demonstrated renewed concern over the allocation of risks relating to the target company's business between signing and closing. Deal parties have tweaked material-adverse-change conditions -- with sellers expressly having buyers assume known identified risks and buyers introducing exceptions for other general categories of risk. Notably, there was an increase in buyers requiring greater protection through financial milestones such as minimum Ebitda and cash-closing conditions.

Looking forward, there is a renewed sense of optimism about M&A activity driven by further strengthening in access to capital, attractive valuations and returns, cash-rich balance sheets and substantial undrawn private equity
capital commitments. If that optimism turns into reality, it is quite likely that there will be further evolution in deal terms from the trends evident in the tight credit markets of the past two years.

Phillip Mills is a partner and Mutya Harsch an associate in the mergers and acquisitions group of Davis Polk & Wardwell LLP. See the online version of this article at TheDeal.com for a chart of recent leveraged strategic acquisitions.