The potential impact of Covid-19 on the world of M&A
As the world grapples with the impact of the Covid-19 pandemic, the pause button has largely been pressed on M&A activity in the UK. Many sellers are focussing on immediate business issues as the crisis unfolds and will be deferring the decision to sell until there is more stability. Trade buyers are also taking steps to protect and safeguard their existing businesses and many are reluctant to engage with the extra demands of M&A at this time of uncertainty. Private equity is largely focussed on its existing portfolio.
It is difficult to predict how long this lack of activity will last – will things bounce back relatively quickly or will M&A take a long time to recover? Only time will tell. However, there are still some deals being done and new ‘hot’ sectors are being created out of this crisis (remote work applications/video conferencing, home delivery, healthcare etc). Inevitably, there will also be distressed deals as the sobering economic impact of the lockdown is felt.
For those M&A deals happening now, the pandemic throws up some legal and practical issues which are shaping the process and deals themselves.
Deals that are beginning
Deals that are just getting off the ground are unlikely to proceed in the manner and form that the parties had previously envisaged.
- Uncertainty affects valuations and pricing structures – what is a competitive price in this uncertain market? The balance of power is generally shifting to the buy-side. Valuations for most sectors may be lower than those discussed based on specific multiples at the beginning of the year. For deals that do go ahead, it is expected that all parties will see increased use of earn-outs to de-risk the deal from the buyer’s perspective. Likewise, buyers are more likely to insist on a completion accounts mechanism rather than a locked box mechanism as this will effectively push back the valuation date of the business and put more of the risk on the seller.
- Cash is king in this market and reliance on third party debt will put buyers at a disadvantage in a competitive auction process. Likewise, sellers will favour buyers who are not dependent on shareholder approval or who require merger control approval to avoid (i) the relative uncertainty of a split signing and completion and (ii) a longer timeframe. A complicated consideration package including shares in the buyer and/or loan notes will not be as appealing to sellers, who will be looking to get as much cash upfront as possible.
- Corporate groups may look to divest non-core businesses and realise cash. This may create opportunities for management buy-outs and also for private equity houses further down the track.
- Buyer jurisdictions will likely correlate to recovery rates. As China recovers ahead of Europe, we may see an increasing number of potential buyers located in Asia. US buyers are likely to take longer to pull out of the crisis.
Deals that are being negotiated
The deal timetable is likely to be extended due to the frictions that the pandemic creates.
- Parties will need to be prepared for the possibility of key transaction personnel absenteeism due to illness or self-isolation. This could include board members and investment committee members, as well as key deal team and advisory personnel.
- Face-to-face meetings and site visits have largely stopped. Technology such as video conferencing is helping with this but obstacles still remain.
- Lockdown issues: barriers have been put in the way of previously straightforward matters such as obtaining shareholder approval, notarisation, filings at Companies House etc. In most cases technology or relaxation of rules by authorities is helping to overcome such barriers but parties need to be prepared.
Due diligence and other legal considerations
Due diligence is likely to be more extensive given the increased risks businesses are facing.
- Sellers need to think about the practicalities of accessing hard copy data room documentation to upload to an online data room during a lockdown when access to offices is very limited.
- Key areas of legal due diligence will include insurance coverage, supplier risk, employment (including furlough) issues, robustness of IT systems, as well as force majeure and termination clauses in key contracts etc.
- Buyers need to consider the following when analysing any Covid-19 related limitations on their due diligence process:
- have any physical movement limitations on diligence teams affected the scope or quality of diligence reports?
- what impact has resulted from any inability to conduct commercial and environmental site visits, meet in-person with management, or engage in other customary face-to-face diligence interactions?
Deals that are between signing and completion
For deals that have signed but not completed, parties will need to consider the following issues.
- The sellers’ obligation to ‘carry on business in the ordinary course’ between signing and completion, which may have seemed easy to fulfil when the deal exchanged, will now need to be considered carefully. Consent from the buyer to take certain actions is likely to be needed. The buyer needs to respond to these requests in a timely fashion.
- A buyer may be able to invoke a MAC (material adverse change) clause or a termination clause to enable it to pull out of the deal due to the impact of Covid-19.
- The warranties given in the share purchase agreement which were correct at exchange may now not be at completion. Sellers should carefully review the warranties given and, if permitted, prepare a second disclosure letter for the buyer. Any material new disclosures may allow a buyer to renegotiate or possibly terminate the deal.
- Clearances, consents and approvals to be obtained between signing and closing might take longer than normal.
- Social distancing means no physical completion meeting can be held. Logistics will need to be considered and powers of attorney obtained in advance as a precautionary step.
- Deal documentation needs to allow for virtual signing. Technology such as DocuSign is increasingly being used to facilitate this.
- Certain institutions normally require ‘wet ink’ signatures for documents to be lodged with them, including Companies House, the Stamp Office (HMRC) and HM Land Registry. Some of these rules are being relaxed as the lockdown continues but again careful planning is required.
Very few would have predicted the current unfolding global pandemic and the effect it has had on so many areas of our lives. We must adapt during these uncertain times and accept that M&A transactions may now take longer and become less predictable than they have been in recent years.
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