The effect of COVID-19 on M&A Transactions
Category: Mergers and acquisitions
COVID-19 and related government measures are having unprecedented effects on the global and domestic M&A market. This is causing immediate effects on the negotiation and formation of deals, while concluded transactions are having to account for various medium and long term effects.
In this context, buyers are particularly challenged with obtaining certainty regarding the target business. Sellers on the other hand are faced with uncertainty surrounding completion, evaluation of risks and managing expectations of the buyer and stakeholders of the target.
In these uncertain times, one needs guidance to evaluate the risk involved in the early stages of a transaction and if the transaction has been concluded, to mitigate damage. As COVID-19 spreads across the world, so too will the relevance of these important issues.
Due Diligence Investigations
As governmental measures are imposed on individuals, businesses and industries at large, the need for thorough due diligence investigations rises. The necessity of higher level reviews and comprehensive reports are being seen from small to large target businesses. More specifically, lawyers are now taking a closer look at, amongst others, the ability of a business to comply with contractual and regulatory requirements; the termination rights of parties to commercial contracts; whether employees are able to work remotely; the country of origin of a target’s supply chains; and the liquidity of the target in view of the obvious challenges.
During this time, the credit arrangements of a target and its constituents should be closely scrutinized to evaluate any exposure. Similarly, if it is determined that loan agreements or other credit facilities are to be entered into, one must examine whether the business would still be able to conclude these agreements with banks and investors. Again, assessing the risk attached to these agreements is a big consideration as protracted financing arrangements will carry inherently more risk during COVID-19 than a short term arrangement. Lastly, whether a target is sufficiently insured and has sufficient crisis management measures in place during the pandemic will be important for the buyer in any acquisition.
Typical valuation methods and procedures are being adapted in view of the impact of COVID-19. In this context, considerations such as the future of the company as a going-concern and the likelihood of recurring income is a common discussion point. COVID-19 has obvious effects on these points and lawyers are facing unique challenges on how to incorporate the correct valuation method into transaction documentation. As a result one is likely to see a general movement towards concluding deals where there is a mechanism to adjust the purchase price after closing which provides more certainty in the valuation of a target business upon closing.
During this time, it is much harder for buyers in certain industries to obtain financing, while sellers will need to take a closer look at maintaining solvency of the target business through its own financing instruments. For buyers that have managed to obtain financing, typically more lender friendly agreements will be concluded during the impact of COVID-19.
Upon becoming aware of certain issues found in the due diligence, buyers may find it useful to include certain Corona-virus related conditions precedents. Typically, this mechanism is in place to suspend or completely waive the conclusion of a transaction until the satisfaction of certain conditions, for example: the transaction will not be concluded until such time as the target business’ workforce is fully operational.
Representations, warranties and guarantees
From the perspective of the seller, one needs a lawyer who can redraft, foresee and at least account for certain eventualities in the way specific clauses are drafted. For example, sellers should be aware of representations which give buyers the opportunity to rely on businesses being conducted ‘in the ordinary course’. In this way, specific carve outs can be negotiated and agreed to which limit risk and responsibility both in the short term (at the time of closing) and in the long term to account for the possibly long lasting effects of COVID-19.
A legal advisor can play a critical role for sellers in obtaining guarantees from parent companies and similarly drafting provisions which protect deal certainty from a financial perspective. On the other hand, for buyers, warranties regarding the evaluation of risks and the forward looking effects of the Coronavirus should be included in the transaction documentation.
The inclusion of COVID-19 in a MAC clause can prove to be critical for buyers during the negotiation and drafting of transaction documentation. Depending on how the clause is drafted, a MAC clause essentially allows the buyer to abandon a deal which has been concluded if the effects of the pandemic or similar crisis continues to worsen. For more information on the drafting and interpretation of MAC clauses, please read further here http://www.advocaten-amsterdam.nl/1637/mac-en-impact-coronavirus.
In the absence of any clause or mechanism limiting risk for the buyer, one can also agree to certain indemnities based on projected risks and liabilities associated with the target. For example, where it could be foreseen that the target will likely face cross-border supply chain interruptions as a result of a supplier being located in a severely affected area, one can negotiate specific indemnities to safeguard against operational and financial damage. For a buyer, having an advisor on your team who is aware of these possibilities provides certainty in a time of external unpredictability.
Special attention should also be given to time periods. Usually, mechanisms such as long-stop-dates are included in share purchase agreements and similar documents to ensure that a contractual obligation (such as closing) or a number of obligations are performed by a specified date. Typically, consequences such as the possibility of termination are attached to non-compliance with the long-stop-date. Inclusion of this mechanism, along with providing certainty, can also take into account the effect of compliance with regulatory implications of COVID-19 and the possible delays in obtaining necessary consents and approvals.
In this difficult time, one needs a team of experienced advisors to help vulnerable companies and review their defences. Parties to a transaction are currently facing an increased potential for disagreement with the negotiation and drafting of tricky topics such as those mentioned above: conditions precedents; representations, warranties and guarantees; MAC clauses, indemnities, carve outs etc.
It is necessary to maintain a realistic perspective of the risks and outcomes involved in a deal and the corporate team of Blenheim Advocaten is here to assist in all aspects involved in the formation and conclusion of a deal during this time.
Please do not hesitate to contact Blenheim Advocaten should you need assistance with any of the topics discussed above or any concluded or pending transaction.