With the global response to COVID-19 continuing to change rapidly, businesses engaged in corporate acquisitions and disposals are facing a period of significant uncertainty. Both buyers and sellers are looking at deal protection mechanisms for transactions which are currently being negotiated. In this short article, we consider the wide range of implications for companies engaged in M&A activity, from the implications of restrictions on travel, to pricing and buyer due diligence.
Preparing for sale
Market volatility and its potential impact on businesses will undoubtedly result in some sellers reconsidering whether this is the right time to market their business for sale. Many potential buyers (particularly private equity) will be focused on portfolio issues and as such may well not have the appetite for major investment in acquisitions. Sellers will be concerned about achieving full value as well as being concerned about considerable uncertainty through the sale process as a result of potential issues with buyer funding and the detrimental impact on the business of lengthy deal processes. This potential delay does not mean that a seller cannot use its time wisely though. They can use it as an opportunity not only to demonstrate that the business is resilient during such uncertainty but also to make sure that its 'house is in order' ready for sale. For example the seller could carry out any reorganisation required to remove dormant companies from a group, review standard terms and conditions in light of current events and implement any business continuity policy updates.
Buyer’s due diligence
For transactions already underway, buyers are increasingly focusing their due diligence efforts on the impact of COVID-19. Whilst previously a buyer may have asked generic questions about any material changes in the business and the contractual terms in place with suppliers and customers, we are seeing buyers raise specific questions about self-isolation rates and recent overseas travel by employees, as well as more general questions about infectious diseases and business continuity arrangements.
As the operational and financial impact of COVID-19 increases, we expect diligence to also focus more on:
(a) contractual and financing arrangements, for example if force majeure and termination clauses are being invoked;
(b) customer payment terms and the company’s outstanding debtors;
(c) customer and supply chain arrangements;
(d) regulatory changes resulting from the pandemic and business continuity/crisis management policies; and
(e) insurance claims.
Acquisition documents
As has always been the case, one of the key elements of an acquisition agreement is to apportion risk between the seller and the buyer both in terms of (i) the transaction completing where there is a gap between exchange and completion; and (ii) what happens if there is a material change in the business during that interim period.
For transactions currently being negotiated, both sellers and buyers may wish to include specific COVID-19 related provisions in their acquisition documents. The appropriate provisions will depend, amongst other things, on the parties’ appetite for risk, their negotiating power and the impact of COVID-19 on the target company. Protections which parties may consider include (i) purchase price adjustments or an element of earn out in case profits are adversely impacted during a specified time period post-completion (or, potentially, mechanisms to add back or partially reallocate the COVID-19 impact to protect the seller); (ii) specific warranties regarding the operational and financial impact on the company; and (iii) where there is a gap between signing and closing, a specific material adverse change clause and/or comfort on availability of funds for the buyer, for example through equity commitment letters or other 'certain funds' mechanisms.
Where there is a gap between signing and closing, restrictions are usually placed on the activities the seller can undertake in this time period. This typically includes a generic obligation to continue to operate the business in the ordinary course. Clearly this may not be possible so a seller should consider whether any carve-outs are required in order for it to be able to respond to emergency situations which arise or where employees are not able to carry out their roles as usual. A buyer’s access rights to the business or specific individuals during this period may also need to be limited where there is a COVID-19 shutdown or self-isolation.
Timing implications
A requirement to obtain regulatory approval, for example from the Financial Conduct Authority or Competition and Markets Authority, is commonly the reason for parties requiring a gap between exchange and completion of a transaction. Whilst organisations are continuing to operate 'business as usual' as far as possible via remote working and reallocation of resources, there is a possibility that timetables may be impacted and extensions granted to statutory timeframes where necessary. Parties should consider this when agreeing an appropriate long stop date for satisfaction of the relevant condition.
Financing
It is too early to tell what impact COVID-19 may have on longer term lending by financial institutions, although the current volatility may make it more difficult for buyers to obtain financing on terms attractive to them in the short term. Sellers should therefore consider how the buyer is financing a transaction and how committed these funds are at an early stage of a transaction and at signing.
How can we help?
If you would like to discuss this briefing please speak to your usual contact at Burges Salmon or Richard Spink.