How is Coronavirus Affecting Private Mergers and Acquisitions?

In this article our Corporate experts talk through the challenges Coronavirus is having on private Mergers and Acquisitions.

How is COVID-19 affecting private M&A - Overview

• As the COVID-19 crisis continues to unfold across the world, many businesses are putting M&A transactions on hold to focus on much more pressing, and often personal, issues. For those already engaged in an M&A process however (or about to embark on one), there is likely to be an impact of the virus on the transaction and there are some immediate issues to consider in a time of such economic uncertainty and unprecedented lockdown measures.
• Transactions where the buyer has a good understanding of the target business and trade sales are likely to be less affected by COVID-19 than private equity backed acquisitions as often trade buyers will have a better understanding of the potential opportunities for targets arising from the crisis.

What is the impact on transactions which are already underway?

• Generally-speaking, the business and economic uncertainty is causing buyers to put their strategic plans to one side and adopt a “wait-and-see approach” as they focus on their core business and retaining healthy cash reserves. Meanwhile, sellers are growing concerned about obtaining full value on a sale as target valuations come under increased scrutiny from buyers.
• There is no doubt that the virus will infiltrate every stage of an M&A process. However, for transactions which are substantially underway and in sectors which are less adversely affected, we are seeing an enthusiasm from both buyers and sellers to proceed.

Due diligence

• Buyers are turning the focus of their due diligence to assessing and understanding how the virus might affect the target business. Some of the key considerations include:
  • the impact of the pandemic on the target's financial condition and prospects;
  • the ability to service debt and control operating conditions;
  • contractual arrangements (including termination rights, force majeure clauses and any penalty arrangements);
  • employee sick leave arrangements; and
  • insurance policies.

What steps can a buyer take in the acquisition documents to limit its risks?

• COVID-19 specific provisions - we are seeing some clients including specific provisions in their documents to address COVID-19. These include:
  • creating a gap between signing and completion with the condition being a lifting of all or certain government restrictions;
  • specific warranties on the state of a business as a result of COVID-19; and/or
  • specific indemnities relating to the state of the business as a result of COVID-19 (typically this type of issue would be priced in but where the seller is comfortable that there will not be material change, they may prefer to give contractual protection).

• Cash retention mechanisms - one way for buyers to get more comfortable is for them to defer payment of part of the consideration. This has the dual effect of retaining the buyer's cash and mitigating its risk.  Common ways that this can be done are:
  • through straight payment deferral/holdback terms (e.g. 10-50% of the consideration will be paid 12 months after Completion);
  • through the use of an earn-out provisions which is tied to the performance of the business over the next year or longer;
  • seller finance (e.g. the seller taking a stake in the acquisition company); and/or
  • price reductions.

• To the extent that the seller is not receiving payment on completion, a seller's key concern will be ensuring that it is going to receive its cash when it is due. Some mechanisms that can assist with this are:
  • the use of escrow accounts (instead of an earn-out which is more likely to be offered by a buyer);
  • the use of parent company guarantees or bank guarantees; and/or
  • signed equity commitment letters from limited partners is fund arrangements undertaking to provide the funds.

What is the effect on conditional transactions which have signed but not completed?

• Any parties engaged in a conditional transaction who have signed an agreement but not yet completed the deal will need to review the agreement to assess whether any provisions could be triggered or in any way affected by the effects of COVID-19.
• Some conditional share purchase agreements will include a material adverse change (MAC) clause that entitles the buyer to walk away from an agreed transaction on the occurrence of an event which materially and adversely affects the target business. MAC clauses are usually heavily negotiated but, in most cases, English MAC provisions will exclude the effect of macroeconomic events (such as COVID-19). Unless there is scope for a buyer to argue that the impact of COVID-19 has disproportionately affected the target business compared to other business in the same industry (which may be particularly difficult given that the risks of the virus have been highly publicised for several months now to all market participants), the buyer would be hard-placed to win this debate.  However, the exact wording must be considered in detail to fully understand the options.

For further information on material adverse change clauses, see our full article here.

What is the effect on transaction timings?

• Whilst we are unable to predict how long the pandemic will run on for or the precise scale of the crisis on the economy, one thing we do know is that delay is inevitable. This is not least because of the practical difficulties parties are encountering in working remotely from home and re-allocating their resources, not to mention various delays and closures of third parties (including government bodies).
• Parties who are in the course of negotiating split deals where completion is conditional upon obtaining consent or a regulatory approval should take these potential delays into account when setting the “longstop date” (the time by which such consent or approval must be obtained). We suggest considering the inclusion of specific drafting to extend the longstop date in the event of COVID-19-related delays caused by third parties.

Financing

• For buyers dependent on third party financing, the current volatility presents yet another obstacle for buyers wishing to obtain financing on acceptable terms. Lenders are exercising additional caution when it comes to the buyer/borrower diligence. Many of their concerns as regards the target will mirror those of the buyer.
• Sellers should drill down into the buyer's financing arrangements at an early stage in the transaction and consider how committed the funds are, before incurring substantial adviser costs.

Impact on new deals & way forward

• The full impact of COVID-19 on the private M&A market will take months to unravel, but with many transactions being pulled or deferred until later in the year, the working assumption is that deal volumes in Q1 and Q2 of 2020 will be considerably lower when compared with the same period in 2019 (despite the uncertainty surrounding Brexit that year).
• However, it's not all doom and gloom. In fact, for some businesses, the prevailing economic conditions translate to an element of opportunity.  Companies with troubled balance sheets and solid business models represent particularly attractive prospects to strategic buyers keeping an eye open for a bargain during the pandemic. We anticipate a rise in the number of distressed sales in sectors such as real estate & construction, hospitality & leisure, retail, travel and aviation, particularly once government and lender support measures fall away.
• At the least, the current crisis gives potential buyers and sellers time to get their house in order and consider how they can emerge from the present chaos in a stronger position. For example, sellers can use the delay as an opportunity to:
  • demonstrate business efficiency and financial resilience during a time of significant uncertainty;
  • consider the current spectrum of potential buyers in the market, make assessments about their interest and health in the current climate and develop an approach strategy;
  • conduct internal due diligence reviews;
  • tidy up or re-organise the corporate structure of the business, particularly if the target company is part of a wider group; and
  • review and update the standard terms and conditions of business to make them watertight in the event of future pandemics or disaster events (with a particular focus on payment terms, force majeure clauses and termination events).

Next Steps

If you have any questions relating to the private M&A market or you're contemplating embarking on a sale or acquisition, please speak to Francis Dalton (Partner), Naomi Spring (Managing Associate) from our Corporate Team.

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If you would like to talk through the consequences for your business, please email us and one of our team will get in touch.