It is no surprise that Mergers & Acquisitions activity has slowed down as a result of the coronavirus pandemic (COVID-19). Most business owners have suddenly had to shift focus to navigating their businesses through the crisis, which has caused some mergers and acquisitions to be delayed.
Many businesses have started to settle into the new normal, however, and deals are continuing to be made regardless of the pandemic. In this article, we outline some considerations for potential buyers who are thinking about Mergers & Acquisitions transactions in the current climate or who had already started the process before the ongoing pandemic.
Few businesses have been able to completely avoid the impact of the virus and parties to a live transaction will need to consider whether COVID-19 affects the valuation of the target business. It may be difficult to assess whether the target business is likely to recover shortly after the government restrictions are lifted or whether there is a risk that the loss of revenue will be permanent.
The parties may negotiate heavily on valuation: the buyer, wanting to guard against the risk of worse-than-expected future performance, and the seller, looking to past performance as the basis of value. In order to bridge the gap, the parties may need to consider whether the acquisition agreement should include a mechanism for adjusting the purchase price after completion, for example through an earn-out provision.
Buyers may also need to review how they are planning to finance the purchase. Acquisitions are usually funded at least partly by debt finance and it may prove more difficult to secure finance in this market. It may be an opportunity to renegotiate the payment terms in light of this.
Due diligence is now more important than ever. Prospective buyers should prioritise due diligence enquiries as early on as possible and buyers who are already engaged in a transaction should review whether to raise further enquiries that could uncover potential medium to long term effects caused by lockdown. Areas calling for greater scrutiny in the current circumstances may include:
- Accounts and financial information
Accounts and financial information should be an integral part of the due diligence process in any transaction, regardless of timing. Buyers should pay careful attention to the financial impact COVID-19 has had on the target business in the short term, including any loss of revenue, pressure on working capital and liquidity, as well as the likely implications in the medium to long term.
Accounts prepared up to the previous financial year-end may well be outdated and prospective buyers will need to obtain copies of more up to date management accounts and forecasts to verify the target’s financial position.
Even so, it may be difficult to estimate how long it will take for the business to recover once the lockdown is lifted and the recovery period is likely to vary depending on the sector. Businesses linked to hospitality, travel and non-food retail are likely to require much longer to recover than convenience stores and pharmacies, for example, and many will have noted the recent announcement by International Consolidated Airlines that it expects recovery in the airline industry to be a very slow one, potentially taking several years. We would expect to see more conditional contracts or heavily negotiated payment structures if recovery periods are slower than initially thought.
Buyers should also review any financial facility agreements to ascertain whether there is a risk of the target breaching any covenants and to see what the implications will be if the lender exercises its rights of enforcement. It may also be necessary to review whether the target is entitled to funding or other support under any government scheme introduced as part of the Coronavirus response.
Buyers should consider the position under any material customer and supplier contracts.
It would be wise to review the relevant contracts to ascertain the possible consequences of non-performance, for example whether a customer will have the right to terminate for non-performance and/or bring a claim to recover any losses it may suffer, or if delayed performance is excused under a force majeure clause. Damage to the target’s existing relationships and reputation should also be considered.
Conversely, a buyer should familiarise itself with key supplier contracts to assess what rights the target has if a supplier is in default. The buyer should make enquiries as to whether there are any suppliers who have already indicated that they may not be able to perform their obligations on time, or at all. It may be necessary to consider whether key suppliers will be easily replaced or whether the target business is likely to be severely disrupted if a supplier defaults or goes out of business.
It is important to review the impact on the target’s employees. Buyers will want to know whether the target has laid off or furloughed any staff as a result of the disruption caused by COVID-19, and whether it is anticipated that key employees will return once the restrictions are lifted.
Buyers may be concerned that any former employees may start on their own once the restrictions are lifted and may try to take clients or staff with them. If any employees have left the business, it may therefore be necessary to review their employment contracts to check for restrictive covenants and confidentiality obligations that may continue to apply after termination.
It is important to also check that the target has sufficient policies, procedures and processes in place to comply with its statutory obligations to protect its staff, including where employees are working from home.
A prudent buyer will also raise enquiries relating to the nature and extent of the target’s insurance cover. Buyers will want to know whether the policies include business interruption insurance covering notifiable diseases, including COVID-19.
If the target does have insurance cover against COVID-19, it is important to check that the target has complied with the relevant obligations, for example any notification provisions, and it may be appropriate to seek a warranty against any acts or omissions of the seller or the target which would invalidate such insurance cover.
Buyers would also do well to review any internal policies on business continuity and disaster recovery plans as in many cases it may be necessary to update these to reflect the lessons learned as a result of COVID-19. This also applies to employment contracts and handbooks.
- Information technology
Depending on the target business, it may also be relevant to raise enquiries relating to IT systems including the resilience of IT systems and any temporary changes support and maintenance arrangements. It would also be sensible to review what arrangements have been made to enable employees to work from home, eg whether security standards have been temporarily relaxed.
Depending on the findings of the due diligence process, it may well be necessary to negotiate appropriate warranties and indemnities to protect the buyer against liabilities after completion.
Split exchange and completion
Where transactions involve a split exchange and completion, sellers are usually required to provide an undertaking that the target business will be run ‘materially in the ordinary course’ during the gap between exchange and completion. This would be a difficult undertaking for sellers to give in the current climate so a buyer would need stronger protections during any gap and may require a right to terminate the agreement altogether if the business drops below an agreed level.
A buyer may also look to negotiate a greater oversight over the target business, for example by seeking additional information and consultation rights during the gap before completion. In any event, a buyer will want assurances that, if the seller makes any changes to deviate from ‘ordinary course’, such changes are in the best interests of the target business.
Buyers may also need to consider whether the seller should be required to repeat warranties during the period between exchange and completion to ensure that they remain true and accurate both during the gap and at completion.
Execution and completion
The parties should also consider the practical considerations surrounding the execution and completion of the transaction.
In many circumstances, it will be possible to sign documents using electronic signatures instead of a ‘wet ink’ signature. Parties may wish to opt for using electronic signatures in order to avoid the need to print, sign and post hard copies. Using electronic signatures can also help prevent delays as many people are working from home and may not be able to access the office on a regular basis. Parties should seek advice on the specific circumstances as not all contracts can conclude via electronic signatures.
Companies House and HMRC, among others, have introduced alternative filing processes during the pandemic so, in most cases, it will be possible to submit any post-completion filings (like stamping of stock transfer forms and filing an updated confirmation statement) electronically.
There may also be other practical considerations relating to handover which the parties should bear in mind. For example, buyers may wish to be able to consult with the sellers to ensure a smooth handover period, and the parties may need to consider whether any site visits and any meetings or consultations with employees can be carried out remotely or deferred.
Although our offices are temporarily closed due to government restrictions, our Commercial Team is working remotely and able to assist clients who are thinking about buying or selling a business this year. For further advice and assistance, please do not hesitate to contact Anna Sivula, Commercial Solicitor at firstname.lastname@example.org or fill out a contact form and we will get in touch as soon as we can.