Written by Kush Birdi, Head of Corporate and Commercial
As of yesterday, the World Health Organization reports 3,349,786 confirmed cases of coronavirus worldwide. Over the coming months, as the world looks to phase from substantial lockdown to normal day-today life, one of the major tasks will be to consider the full economic effects of coronavirus. The situation is evolving day-by-day but we are already seeing a downturn in M&A activity.
Both buyers and sellers have reason to be cautious as they are busy consolidating their own cash position. In the short term, it won’t be surprising to see sellers waiting to see what happens and reviewing their sale a few months after the coronavirus lockdown is lifted, and a sharp increase in buyers withdrawing from deals, putting deals on hold or seeking to re-negotiate terms with sellers. However, that is not to say that transactions can’t happen or that sellers can’t prepare their businesses ready for a sale when the pandemic comes to an end.
Will the M&A process be different?
- We expect there to be a more focused approach to contractual negotiations in M&A deals. We anticipate that:
- Buyers will increase their scrutiny of key documents around business continuity planning and dealing with emergency situations.
- Buyers will want to know about what, if any, steps have been taken by sellers to make use of the various financial support packages announced by the Government.
- Additional representations, warranties and indemnities relating to coronavirus specific risks may need to be given by sellers in order to get deals over the line.
- Sellers may be faced with slow-moving buyers as the economic uncertainty and market volatility causes buyers to adopt a “wait-and-see approach”.
- The computation of accounts and management accounts may be unreliable.
- Buyers will try to argue that the coronavirus represents or should represent a material adverse change (MAC) to trigger the right to walk away from deals already exchanged.
How will price structures be affected?
Most commonly, a buyer will pay an initial price known as the “enterprise value”, followed by a post-completion price adjustment using a pre-agreed completion accounts process (taking account of the actual levels of cash, debt and working capital at completion). In recent years, there has been an increase in the use of the alternative “locked-box” mechanism where the price is fixed before completion and there is no post-completion adjustment except in relation to unapproved payments or liabilities known as “leakage”.
Buyers generally prefer to adopt a traditional post-completion adjustment, but, during these unprecedented times, we expect to see a rise in the use of deferred consideration or earn-out price structures. Earnouts tend to benefit the buyer (except in strong performing sectors) because the final purchase price is tied to the future performance of the business.
Sellers should pay extra attention to earn-out formulas as they can heavily influence the final purchase price, especially if the business is going to be affected by the coronavirus pandemic but may achieve substantial growth after it ends.
We expect the majority of sectors to experience a decline as a result of the coronavirus pandemic, however M&A deals will continue to take place even if they involve some unusual adjustments in the current environment. Whatever happens, buyers and sellers shouldn’t act without taking legal advice and should work with the right team of experts who are capable of protecting their interests.
For more information, please email [email protected] or contact Kush on 020 8305 4230.