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Shifting Dynamics in Private Equity

February 9, 2024
The biggest impact of the deceleration has been the resulting shift in the nature of deal terms…. We’ve seen a reversion in negotiating leverage — a return to more balanced and, in many cases, more buyer-friendly deal terms.
Rory ffrench, Partner in the Private Equity group
With the return of private equity activity to pre-pandemic levels in Canada, there has been a distinct shift in the way parties approach deal terms. Blakes Partners Rory ffrench and Rianna Ritchie walk us through some of the most significant trends, drawing on insights from the fourth edition of our Canadian Private Equity Deal Study.


Jordan: Welcome to the Blakes Sound Business podcast. I’m Jordan Virtue.

Nathan: And I’m Nathan Kanter. In this episode, we look at recent trends that define the new normal in the private equity market with insights from the fourth edition of the Blakes Canadian Private Equity Deal Study.

Jordan: Much has changed in the two years since the last edition of the study, which captured the unrelenting deal activity during the COVID-19 pandemic. To discuss some of those changes and help us understand “what is market” now, we’re joined by Rory ffrench and Rianna Ritchie, Partners in our Private Equity group.

Nathan: Rianna, before we dig into some of the findings of the study, could you give us a snapshot of recent trends in Canadian private equity?

Rianna: Yeah, so this edition of our study is going to reflect the general deceleration of dealmaking activity that we’ve seen in the market since the record-breaking and really unprecedented activity levels we experienced in 2020 and 2021 — a real return to pre-pandemic deal volumes but also a marked shift in the way that parties are approaching deals in rather uncertain market conditions. With inflation, credit tightening, higher borrowing costs, insolvency activity and also international geopolitical concerns, we’re seeing parties and particularly PE buyers approaching transactions in a more cautious and calculated way.

That said, deals are still getting done, both domestically and across borders, especially inbound from the U.S., and in terms of industry, Canadian tech and media companies, in particular, continue to draw investors to Canada, and we’re still seeing strong activity in the industrial goods and services, life sciences and financial services spaces.

Ultimately, the pace of dealmaking and the terms on which deals are done are a departure from the aggressive market dealmakers were playing in a couple of years ago, and our analysis of Canadian PE buyouts and investment transactions reflected in our latest deal study is going to highlight that.

Jordan: Rory, could you tell us a bit more about the deceleration of deal activity to pre-pandemic levels after a frenetic 2020 and 2021? What does the study reveal about the effects of this trend?

Rory: The biggest impact to the deceleration has been the resulting shift in the nature of deal terms. As Rianna had mentioned, from 2019 to 2021, we saw a high-octane deal environment. There were lots of auctions, there was a lot of dry powder, an abundance of buyers ready to use that dry powder and low-cost financing. It was a perfect recipe for seller-friendly deal terms.

But with the deceleration in 2022, and even continuing into 2023, we’ve seen a reversion in negotiating leverage, a return to more balance and, in many cases, more buyer-friendly deal terms. Perhaps the perfect illustration of this can be seen in our study’s look at no-seller-recourse deals, which are sometimes called public-style private transactions. The key characteristic of this type of transaction is that the seller’s representations and warranties do not survive the closing, and so the buyer’s sole recourse for that kind of transaction is to go to a rep and warranty insurance policy, or if they didn’t want to buy the policy, perhaps to self-insure.

The fourth edition of our study looks at 2019 through 2022, but we have a nice database that lets us dig a whole lot farther back, and so if you actually go dig farther back and you look at what’s been going with the survival of general and business representations, you saw that there was no survival in only 5% of deals in 2015. That steadily rose over time to about 17% in 2019 and then skyrocketed when we got into the high-volume environment of 2020 and 2021 up to 48% of deals, right at that seller-friendly peak.

Back in 2022, when we started to see the deceleration, it’s reverted back down now to 43%, and I think we’re going to start to see it continue on down. Fundamental reps and warranties have always lagged behind the general reps and warranties when you start talking about the acceptability of no seller recourse. I think buyers in Canadian deals have always been saying they feel a little bit leery of the idea of letting a seller off the hook on something that goes to the heart of the deal — the, “you, the seller, actually have title to the very thing that you’re telling me that you’re going to be able to sell to me.” But even in this hot seller-friendly environment, we started to see that similar trend of no seller recourse on fundamental reps and warranties.

Again, if we look back at the data, back in 2015, there were no deals that had no survival of fundamentals, but that crept up a little bit slowly, up to about 11% in 2019, spiked at 35% in 2021 and then fell back to 32% in 2022. Some of this may have been driven by the fact that rep and warranty insurance premiums were also reaching record highs, and so I think both Rianna and I probably had a whole number of buyers that were saying, “that product is just a little bit too expensive for us now,” and so they started to look at more traditional indemnification models. But it all sort of depends, and there’s an ebb and flow to all of this, and so perhaps we will see it turn around again.

Nathan: Rianna, earnouts enjoyed a bit of a heyday in 2020 and 2021, but their popularity has since declined. What does the study tell us about that?

Rianna: Yes, earnouts were all the rage a couple of years ago to address the economic or, frankly, worldwide uncertainty and valuation gaps that were on everyone’s minds at the time. The analysis we’ve done, as well as our day-to-day experience, is telling us that earnouts have recently fallen out of favour relative to the peak a couple of years ago.

And just to highlight more precisely what we’re seeing, in 2022, we saw deals with earnouts as much as we did in 2019, and then in 2020 and 2021, the number of deals involved in earnouts were approximately double to what we saw in 2019.

And we’ve identified some patterns and how parties are thinking about earnouts and spent some time considering the rationale behind this pretty seismic shift. And what we’ve identified is that dealmakers have come to appreciate that earnouts need to be carefully crafted, and the negotiation of earnout terms as well as earnout-related structuring can cause deal negotiations to drag on and means the parties must continue to deal with one another — and, in some unfortunate cases, squabble with one another — following closing in a way that a lot of clients would prefer to avoid.

All that said, as part of our deeper dive into this earnout shift, we’ve added a new feature to our latest deal study where we’ve broken down not only the incidence of earnouts, including their duration and size, but also the nature of the negative covenants associated with the earnouts we’ve seen. So, for instance, the majority of deals we’re seeing reflect that a buyer can’t act in bad faith or take deliberate steps with a primary intent to reduce an earnout. On the other hand, it’s less common for us to see more specific requests with respect to the conduct of a business post-closing to, for instance, maintain pre-closing company branding like a company name.

And ultimately, instead of choosing earnouts, we’re seeing a preference for parties to meet in the middle when valuation gaps are identified and generally keep deal terms simple.

Jordan: Rory, I wanted to circle back on your comments about interest in R&W insurance waning a little in 2021 as insurance premiums reached record highs. The study shows that premiums levelled off in 2022 but still remained high. Can you put that in context for us? Has R&W insurance use started to return to pre-pandemic levels yet?

Rory: Of course, and it’s a good question. Our study shows the average premium as a percentage of policy limit for each of 2019 through 2022. So, you’re right, you do see an average of 2.65 in 2019, and it jumped up to about 3.5 into 2021 and 2022. But I think you have to look a little bit deeper on this and dig in on perhaps a quarterly basis, and thankfully we have the database and all the deal data to be able to do this.

And so, when you look at the actual deal data on a quarter-by-quarter basis over the last few years, you see that the premiums were hitting a record high in Q4 2021 and Q1 2022. But as Rianna said at the very outset of this podcast, that was the very peak of our deal volume. And so, I think what we’re really seeing when you see this very high average in 2022 is actually an overweighting of the early part of 2022 and an underweighting of the lower deal volume Q3 and Q4 2022 deals where you started to see the premiums going down, and indeed they have gone down. So now, if you were to look around Q4 2022, you saw premiums around the three, 3.5 range. And now into 2023 even, we’re starting to see them more into the mid-two range, and that has brought back a lot more interest into rep and warranty insurance policies and brought it back to a more regular part of the toolkit for M&A advisors.

I think we’re now starting to see our buyers that are considering rep and warranty insurance not just as the rep and warranty insurance product itself but also similar or adjacent products, whether they are interim breach coverage or specific tax policies to address issues to allow them to try and, again, solve problems, issues, uncertainties, even known issues that we’re finding in transactions to allow us to get our deals over the line.

Nathan: Rory, Rianna, thanks for taking the time to share these findings.

Jordan: Listeners, to download a sample or request a full copy of our Canadian Private Equity Deal Study, please visit, all one word.

Nathan: Until next time, stay well.

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