How is COVID-19 affecting your M&A transaction?
Aimee Craig, Associate in the Corporate team at Tughans, picks up on certain considerations in the M&A market at this time.
As the COVID-19 pandemic continues this uncertainty creates a difficult backdrop for corporate deals. We set out below some of the potential impacts on M&A transactions and some suggestions on how to manage such risks.
Greater uncertainty around reaching completion of a transaction may result in increased concern as to who covers costs. Generally speaking, costs is negotiated in the early stages of a deal and it is expected that buyers will largely continue to bear their share of the risk that a deal falls over, leaving them with such costs. Buyers may therefore want to manage their costs exposure by prioritising key areas of due diligence as set out below, deferring other expenditure to later in the process when there is more certainty that agreement can be reached.
It seems only logical that a greater emphasis be placed on due diligence, with a specific focus on insurance, employment, terms of material contracts, supply chains, business continuity and disaster recovery plans, and health and safety policies are clearly something that any potential purchaser must now place at the centre of their focus.
Sellers should ensure that they disclose all relevant material information and documentation, including up to date details of their contingency planning in respect of COVID-19. Sellers will be best advised to demonstrate to buyers that they are sufficiently prepared.
Online data rooms will be key so companies who are in potential sale mode should have such a data room set up and be as organised as possible in the collation of documentation. Should you need us to share a stereotypical list of legal due diligence questions please let us know.
Although the key aspects of a business may be otherwise fine, the uncertainties surrounding the impact of COVID-19 will likely lead to a fall in valuation. In these circumstances, an increase of earn out provisions (where payment of a material part of the purchase price is contingent on the future performance of the target business) may occur in order to provide buyers comfort on consideration. That said, from a seller’s perspective, the uncertainty may mean that those who have a choice are not willing to accept an earn out structure. Price certainty is a good thing for any seller and locked box pricing has become an increasingly common feature of M&A deals, particularly in a competitive process.
Given the extent of the impact COVID-19 could have on current trading, buyers may often stipulate that there must be a post completion price adjustment in the form of a traditional completion accounts mechanic. Historically, the most common bases for adjustment were net debt and working capital. However, given the current environment, buyers may also seek adjustment based on revenue or earnings up to completion.
Deferred consideration, retentions and escrow arrangements
In such a turbulent market, it is increasingly more probable that buyers will seek to defer payment of consideration, even if there are no conditions attached to payment other than timing. Many such provisions for deferred consideration will turn into retentions, where a buyer has the ability to utilise the deferred consideration to cover purchase price adjustments, warranty claims and other contractual remedies against the seller.
Sellers will generally seek to negotiate against a retention, or seek an escrow, with the deferred consideration being held by a third party. This should give sellers a little more comfort that they will get their money, and can also provide them with comfort if they have any concerns over buyer solvency post completion of the transaction.
Conditionality and termination rights
M&A deals frequently comprise conditions that have to be satisfied or waived before a longstop. Only when satisfied or waived can completion take place, failing which one or other of the parties can move to not completing the transaction.
For deals that have yet to sign, it is likely that an increased focus is placed on conditionality, potentially notable in and around:
- important contracts: conditions relating to the continuation of key supply and customer contracts could become more prevalent; and
- long-stop dates: there may be increased pressure to extend long-stop dates, in particular if regulatory conditions need to be fulfilled and the impact of movement and travel restrictions impacting staff at parties making such decisions may mean practically speaking approvals take longer to obtain.
Covenants that regulate the conduct of the target business between signing and completion should be scrutinised. Sellers should seek maximum flexibility to respond to COVID-19 issues as they arise, without having to obtain the buyer’s consent in advance.
Warranties and indemnities
In addition to warranties that address COVID-19 impacts, including those relating to the target’s material contracts, financial position and contingency plans, buyers could seek to address specific risks by way of indemnity. Buyers may also be in a stronger position to insist on the repetition of warranties at completion. Equally, sellers will want to ensure that they have fully disclosed all COVID-19 risks as far as possible in order to mitigate their exposure to claims.
If warranty and indemnity insurance has been considered, any exclusions within the policy should be carefully reviewed. As COVID-19 is a known risk, related losses will in all likelihood be excluded from W&I policies.
Both buyers and sellers will want to ensure that any conditions in the buyer’s funding facilities stand alongside the sale and purchase agreement. Failure to deal with this could lead to the parties finding themselves with an unconditional deal for which financing is not available. Buyers are often reluctant to share details of their funding, but sellers should now insist on having comfort in this regard.
Potential buyers might seek to lessen their risk by adopting a different approach to transactions, by (i) acquiring a shareholding in the target rather than the entire share capital, potentially with an option to increase the stake in the future when the market has settled or (ii) investing in alternative forms of capital such as convertible loan notes, convertible preference shares or other instruments which give a right or ability to buy shares in the future.
M&A transactions can prove challenging at the best of times, and there is undoubtedly even more to consider with COVID-19. Parties need to ensure that they carefully consider not only those aspects discussed above but engage advisers who understand their objectives and the markets in which they operate.
Please get in touch with a member of our top ranking corporate team if you have any queries or are considering a sale or purchase. Our corporate team is led by Head of Corporate James Donnelly, Partner John McGuckian and Consultant John-George Willis.
While great care has been taken in the preparation of the content of this article, it does not purport to be a comprehensive statement of the relevant law and full professional advice should be taken before any action is taken in reliance on any item covered.