The impact of COVID-19 on domestic and cross-border M&A
June 2020 | SPECIAL REPORT: MERGERS & ACQUISITIONS
Financier Worldwide Magazine
June 2020 Issue
The ongoing coronavirus (COVID-19) pandemic has undoubtedly had a significant impact on both domestic and cross-border deal activity, with many potential buyers focused on saving cash and keeping their own portfolio companies in order. On the flip side, potential sellers are increasingly concerned about purchasers’ certainty of funds, as well as lower valuations for their assets.
However, M&A activity has not come to a complete standstill. Cash-rich buyers are well-positioned to take advantage of lower value targets, and activity in certain sectors remains strong by virtue of the nature of the crisis, for example in the medical technology and life science industries. In this article, we consider some of the key issues facing parties to an M&A process, in particular a renewed focus on critical diligence items and certain deal terms, and how to successfully navigate that process.
Due diligence
Site visits have become extremely challenging, if not impossible, to undertake as a result of the current crisis. During the ongoing lockdown period, buyers should maintain focus on due diligence that can be achieved remotely, and sellers should ensure that they both set up and maintain an easy to use and comprehensive virtual data room.
Specific areas that buyers are giving sharper focus to include whether sellers’ customer and supplier contracts include termination and force majeure provisions that counterparties have already triggered or may be able to trigger. Are the seller’s insurance policies sufficient to cover the losses the seller might be expected to experience over the coming months, for example if disruption in the supply chain prevents the seller from fulfilling orders and leads to claims for breach of contract? Have the financial covenants in the seller’s debt documentation been breached, and are their lenders seeking to enforce any mandatory prepayment provisions as a result? Who are the outstanding debtors of the target, what is the quantum owed to the target by such debtors, and what are the payment terms? Have any employees been furloughed, and are other employees set up to work remotely without any significant detrimental impact on the business?
Transaction documentation
The current crisis represents an opportunity for buyers to renegotiate the purchase price down, even late in the transaction timetable. They will also aim to shift payment obligations as late as possible, whether by way of earn-outs or other purchase price adjustments to counteract any forecast reduction in profits of the seller in the period following completion. Sellers, by contrast, should be looking in detail at the buyer’s certainty of funds, to mitigate the possibility of the buyer withdrawing from the transaction at a late stage of the negotiations.
Particular focus should be given here to the buyer’s cash position and whether any third-party debt arrangements are being put in place to help the buyer finance the acquisition. If such external funding is being set up by the buyer, the buyer will need to ensure that any provisions included in the debt documentation protecting lenders from adverse changes resulting from the current crisis are mirrored in the purchase agreement. The buyer cannot find itself in a position where the proposed lender is able to withdraw from its funding obligations, while the buyer is still obligated to complete its purchase of the target or the target’s business.
Aside from the purchase price and any deferred payment provisions, buyers will also need to pay close attention to the drafting of specific warranties and indemnities regarding the financial and operational state of the target. Buyers should not be relying on generic warranties; real focus needs to be placed on drafting specific warranties and indemnities to protect buyers from issues that have arisen in due diligence.
Where there is a gap between signing and completion, buyers should also insist on having the warranties repeated prior to completion, as well as looking to insert specific material adverse change (MAC) clauses into the purchase agreement. MAC clauses operate to afford the buyer a termination right prior to completion of the acquisition on the occurrence of certain specified events that are detrimental to the target company.
Sellers will of course look to exclude the effects of COVID-19 on the target’s business from any MAC provisions agreed with the buyer, but their success in doing so will depend largely on the relative strength of each party’s negotiating position. As always though, sellers, if they are accepting a MAC clause, should not agree to any provisions that give the buyer a walk away right when a general macroeconomic event has occurred. The drafting must link the macroeconomic event, such as the COVID-19 crisis, to a detrimental effect on the target’s business, and that detrimental effect should be objectively defined, for example by a fall in the target’s earnings before interest, taxes, depreciation and amortisation (EBITDA).
Care should also be taken in respect of the provisions relating to the conduct of the target’s business between signing and completion. Usually, there will be an obligation on the seller to operate the business in the ordinary course in this interim period, but sellers should seek to negotiate certain exclusions where emergency actions outside the ordinary course are needed to be implemented quickly in light of the current crisis.
The parties will also need to consider carefully timing issues in respect of the conditions to closing that are included in the purchase agreement. In the current climate, consent from any relevant key customers, suppliers and requisite regulatory authorities may take longer to obtain. It will therefore be essential to evaluate the timing of any agreed long stop date very closely. Sellers do not want to be in a position where a purchaser can walk away at the agreed long stop date simply because the requisite consents have taken longer than usual to come through.
Philip Watkins and Tom Braiden are partners at Brown Rudnick LLP. Mr Watkins can be contacted on +44 (0)20 7851 6162 or by email: pwatkins@brownrudnick.com. Mr Braiden can be contacted on +44 (0)20 7851 6085 or by email: tbraiden@brownrudnick.com.
© Financier Worldwide
BY
Philip Watkins and Tom Braiden
Brown Rudnick LLP