Remember the halcyon M&A days of February 2020, with face-to-face negotiations, management presentations and site visits?
Well, we are now obviously operating in a completely different and evolving M&A environment, but one in which some emerging trends are starting to develop. Here is a headline summary of some of the trends and issues that we are beginning to see.
Heightened due diligence
More extensive due diligence by buyers to deal with specific issues arising out of COVID-19, for example:
- Material contracts – can key customers or suppliers terminate as a result of COVID-19? Can the parties still comply with their contractual obligations? Is there a force majeure regime and is this broad enough to cover COVID-19? What are the related risks of litigation?
- Solvency – what is the ability of the target to withstand liquidity issues arising out of the crisis? Is the target eligible to apply for Government emergency funding and, if so, has it done so and on what terms?
- COVID-19 legislation – review of compliance by the target with COVID-19 laws and regulations, for example relating to employee safety and the furlough regime.
- Corporate governance and residency – can the target’s various bodies function effectively in the current climate? Will there be any corporate residency challenges as a result of COVID-19?
- Insurance – does the target have insurance policies in place which cover current and potential future losses arising out of the crisis?
- Supply chains – where are they located and what is the impact of COVID-19 on the ability of suppliers to continue supplying the target?
Key issues, often arising out of a more aggressive stance taken by buyers, include:
- Purchase price adjustments – can the parties agree a purchase price mechanism which gives adequate protection and certainty for both sides? Buyers will seek protection against negative developments in the target business by means of completion accounts mechanics (rather than locked box accounts), and also by means of post-completion protection provisions relating to, for example, deferred consideration and earn-out mechanics.
- Deal conditionality and termination rights – buyers are likely to look for additional conditionality and/or termination rights. For example, will a material adverse change (MAC) clause become more prevalent in the UK market? Any such clause is likely to be resisted at first by sellers and, if accepted, is likely to be bespoke to the material risks and issues for the target arising out of COVID-19. Third party approval conditions and related long stop dates will need to take into account the potential for delays arising from the current situation.
- Interim operating restrictions – sellers will need to take particular care in relation to interim operating restrictions covering any gap period between signing and closing, whereas buyers will be more focused on this issue. Any provisions relating to buyer access to the business between signing and closing will need to be considered carefully – can they actually work in the current situation?
- Non-COVID-19 issues – buyers are likely to take a firm stance in relation to any material issues not related to COVID-19 which are identified in its due diligence and will look for the seller to bear the cost of these (e.g. through a purchase price reduction or an indemnity).
- Warranties – sellers will need to take particular care in relation to any repetition of warranties at closing. Further, specific warranties relating to COVID-19 may become standard practice and sellers will need to prepare disclosure bundles carefully to ensure that issues arising out of the crisis are addressed adequately.
- Warranty and indemnity insurance – although “traditional” W&I insurance policies are perhaps unlikely to be a solution for COVID-19 risks, other insurance products, such as cash release insurance or, for distressed and insolvent transactions, synthetic warranty protection, could help to facilitate transactions in the current climate.
- Boilerplate clauses – even boilerplate clauses will need to be reviewed to check that they are fit for purpose in the current climate. For example, notice provisions should allow for service by email.
Déjà vu all over again?
It will be interesting to see whether COVID-19 has a similar impact on M&A strategy to that of the global financial crisis of 2008. If it does, then we may see some or all of the following approaches becoming more prevalent:
- Focus on increasing liquidity – companies considering recapitalisation proposals as well as potentially the sale of non-core assets or even high-value assets that would otherwise normally not be for sale.
- Buyer strategic partnerships or joint ventures – to reduce the overall exposure for individual buyers.
- Sales of less than 100% of a company – as a way of sharing valuation risk between the seller and the buyer.
- Investment using preference and/or convertible shares – to reach an agreement on valuation.
This is necessarily only a headline summary of the trends and issues outlined. Should you require further advice, please contact Carl Powlson on 020 7429 4963 or email@example.com, or your usual Shepherd and Wedderburn contact.