Written by Leena Patel, Corporate and Commercial Solicitor
In this article, I explore some of the key themes that we expect to see in M&A negotiations during the coronavirus pandemic and in the aftermath of lockdown.
As the UK continues to deal with the spread and effects of the coronavirus, many business sectors are struggling to keep afloat. While this has caused many M&A deals to be delayed or aborted, other deals continue to progress on the same or revised terms.
So, in a world of sustained social distancing measures and an ever-changing and unpredictable economy, what do we expect will be the “new normal” in M&A transactions over the coming months (and possibly years)?
Enhanced Due Diligence
The need for the buyer to carry out detailed and focused due diligence on the target company is of prime importance. Buyers should focus on the commercial and practical impacts of the coronavirus, such as:
- Its ability to function remotely
- Its ability to maintain payment of its debts
- As they fall due, and to meet its fixed obligations
- The ability to control operating costs
- The future financial projections of the target
- Its key contracts and the termination or suspension rights of each party (including force majeure clauses)
- Regulatory and legal compliance risk factors
Buyers will need to consider the consequences of non-performance of any material customer and supplier. For example, a buyer should clarify whether any existing suppliers of the target have indicated that the provision of goods or services may be delayed and, if so, what alternatives are available to allow the target to continue its business. So, if the target is heavily reliant upon one particular supplier, any current or foreseeable barriers to that supply chain is likely to present a significant operational risk to the target (if not right now then perhaps in a few months’ time).
Warranties are commonly a subject of much debate between buyers and sellers. Thrown in the midst of the coronavirus, the repetition of warranties where there is a split exchange and completion may present a more intense negotiation.
Sellers will want to resist any repetition of warranties given the current uncertainty, whilst buyers may strongly seek the repetition of particular warranties, especially where they are material to the running operations of the target and its ability to continue its business.
In addition, buyers will want to insist on including specific warranties on the status of key contracts and disaster recovery plans.
Sellers will undoubtedly be cautious about making additional disclosures but they should do so if they want to mitigate the risks of claims being made against them after completion.
In particular, sellers should consider making specific disclosures in light of the coronavirus pandemic, especially against warranties covering events since the last accounts date, supply contracts, compliance with laws and the target’s financial status.
Depending on the sector in which the target trades, it may be necessary to obtain regulatory, licensing or change in control approvals.
The parties are encouraged to consider the particular requirements and likely timelines for these in light of the current pandemic, and consider whether any delays will impact on the timeframe of the transaction.
The financial effects of COVID-19 may be rapid and intense with the target expected to recover losses once social distancing restrictions are eased.
However, buyers should strongly consider whether the impact of the coronavirus needs to be factored into their valuation of the target before an offer is made.
We have all heard of the traditional EBITDA valuation but, faced with significant uncertainty, valuing businesses will be more complicated and there is likely to be a stark difference between a buyer and a seller valuation of the target. The lockdown may well lead buyers to insist on earn-out price structures where the risk of the future performance of the target is, arguably, allocated more fairly between buyers and sellers. Earn-outs do however come with a number of issues, from negotiation difficulties to a real possibility for quarrels after completion.
For buyers seeking finance to help fund their acquisitions, there may be significant hurdles to face with lenders and investors given the fast changing market. Lenders and investors will have similar due-diligence concerns to buyers regarding the future prospects of the target and will be more risk averse when conducting their own due-diligence against more stringent lending or investment criteria.
Furthermore, additional security requirements may be required to protect against the risk of buyer default, so buyers will need to get their ducks in a row well before they submit their proposals for finance or investment.
For more information, please email [email protected] or contact Leena on 020 8305 3539.