updated on 14 April 2020
QuestionCovid-19: How is the pandemic impacting negotiations in M&A deals?
With the impact of covid-19 becoming more pervasive by the day and at a time when governments around the globe are battling against illness and economic hardship, the worldwide M&A market is facing a period of significant uncertainty: sale processes and negotiations have slowed down; valuation of target businesses has become more difficult; and prospective buyers and sellers need to identify specific covid-19 related issues in order to apportion risk appropriately in their transaction documents.
Here are some areas which are likely to be in the centre of negotiations in M&A transactions in the context of the pandemic.
Purchase price and price adjustment mechanisms
From a purchaser perspective, the crisis provides an obvious ground to attempt to drive down the purchase price of the target business. On the other hand, the seller may argue that the pandemic will not have a lasting impact on the business model and therefore should not affect the value of the target.
Price adjustment mechanisms will be useful tools to apportion the risk of negative impacts on the target business between the buyer and the seller. Such apportionments of risk will depend on many factors, including the parties' bargaining power and their appetite for risk.
For example, negotiations may include discussion of a possible earn-out mechanism which differs slightly from the more common mechanism we see in more normal circumstances. Under this variation to the normal mechanism, the seller's payment will (as is usually the case) depend on the earnings of the target business over a period of years. In most cases, the target business will be valued during the negotiation process, and a lump sum payout will be determined. Where this differs from the norm is that this payout will be spread over several years and will be tied to the profits of the business in such a way that if profits are high, the payouts are made more quickly.
Warranties and indemnities
The purchaser may insist that the seller's warranties and indemnities should reflect any covid-19 issues which may have come up during due diligence including, for example, in relation to force majeure or termination clauses invoked for any contractual and financing arrangements.
From a seller's perspective, particular care should be taken in accepting that such warranties or indemnities will be given, especially where these will be repeated at closing (in cases where there is a gap between signing and closing).
Sellers will be keen, if at all possible, to avoid any conditionality which is likely to result in a delay to the receipt of sale proceeds. However, where there is a gap between signing and closing (eg, pending mandatory regulatory approvals), a material adverse change clause (MAC clause) is one of the most commonly used and heavily negotiated tools to apportion risk.
A MAC clause essentially allows one party (usually the buyer) to pull out of the acquisition prior to completion in the event that a material adverse change has occurred in the period between exchange and completion which adversely affects the target company. The inclusion of a MAC clause typically shifts risk on to the seller and can leave the seller exposed to events outside of its control. As such, a seller will generally resist its inclusion. From a purchaser's perspective, a MAC clause may provide the necessary reassurance to go ahead with the deal.
If the parties agree to the inclusion of a MAC clause, they will need to make sure that the events and conditions which will amount to a MAC are objective and carefully defined. A 'corona' clause which specifically addresses the current situation may well be required, although agreeing the parameters of that clause will be complex and will certainly prolong negotiations.
Future of M&A activity
There is definitely a slow down in sale processes as businesses are adapting to new ways of working. At the moment, businesses are very much focused on mitigating the effects of the virus on their existing business. However, the expectation is that M&A activity will not come to a complete standstill. Of, course it is hard to imagine that there will be a surge of activity in industries severely affected by the pandemic (eg, retail, travel and leisure), but there will be other industries, such as healthcare, where opportunities may arise. M&A may also be an option for businesses who are facing financial hardship or insolvency as a result of the crisis.
Nikoletta Zinonos and Joanna Monaghan are lawyers at Burges Salmon. Nikoletta is a trainee solicitor and Joanna is a corporate director.