Corporate buyers and sellers are now reevaluating their merger-and-acquisition (M&A) prospects amid the coronavirus disease 2019 (Covid-19) pandemic. As this public health crisis continues to cause business disruptions and economic unrest worldwide, businesses face the unique challenge of dealing with uncertainties while struggling to stay afloat during this time.
For most buyers, timing is crucial and vital in ensuring an M&A success in maximizing its value creation. With the continued unease caused by the pandemic, deal decision-makers face the critical challenge of making a carefully planned and well-timed M&A decision. This article discusses some legal and practical considerations that parties should keep mind of in navigating M&A deal-making amid the pandemic.
Conducting thorough due diligence is a vital step, since it facilitates risk exposure discovery, deal value validation and identification of bottlenecks that could derail a deal. Due to government-mandated lockdown and other restrictions, information gathering has never been more difficult, especially for asset purchase deals requiring ocular inspections and cross-border M&As.
A deeper scrutiny of Covid-19’s impact on business operations and continuity plans is necessary. Important areas of focus also cover key commercial contracts with force majeure clauses, whether the outbreak could trigger this or not, and the legal and financial repercussions for the target company. Would there be material contract terminations and key customer-supplier loss risks? Would this pose a material variance on its future value? Would this impact the seller-owner’s representations and warranties, and disclosure obligations? These are some of the issues parties should keep in mind.
A fundamental concern, especially for negatively affected industries, would be the potential widening of valuation gaps as a result of key financial assumptions’ distortion, Ebitda adjustments, and impact on projections tied to future earnings and cash flow. As the pandemic’s impact continues to unfold, parties not only face increased completion risk, but also start paying more attention to increased misvaluation risks (risks of misvaluing the target company) and value-shift risks (risks that the closing valuation may depart significantly from the signing date valuation).
To avoid buyers from overpaying, we expect to see attempts to manage pricing risk through contingent payment mechanisms or earn-outs, purchase price adjustments, representations and warranties tailor-fit to cover matters affected by the pandemic, and indemnities.
Sellers, on the other hand, should deal with calls for a possible purchase price reduction to account for Covid-19’s interim effects on business operations. With the uncertainty surrounding the pandemic’s long-term impact, sellers would likely negotiate giving more weight to pre-pandemic valuations on the assumption that disruptions are merely short-term, and has globally affected businesses in general.
Key contractual provisions
A well-designed contract can be an efficient way to address and mitigate potential M&A risks, both from the buyer’s and seller’s perspective. Parties to an M&A will attempt to heavily negotiate the material adverse change (MAC) clause, with the buyer arguing for an extensive scope to cover unpredictable risks, and with the seller pushing for specific carve-outs.
This clause is a risk allocation mechanism designed to shift risk from one party to another. In an M&A context, this addresses uncertainties in between signing and completion, and tries to outline events that, if they occur and cause material adverse change in the target’s business, would allow the buyer to walk away. Common wording of a MAC clause would capture the occurrence of a pandemic, which almost certainly covers Covid-19.
Depending on the parties’ bargaining position, sellers in transactions under negotiation may resort to pushing for a seller-friendly MAC clause with specified exceptions. If carving out Covid-19 would be practically unfeasible, sellers could attempt to exclude changes in general economic conditions and the financial markets, which, while also impacted by the pandemic, may arguably be caused by outside factors not solely constricted to Covid-19. In addition, parties should be wary of execution costs from potential disputes on the MAC clause’s interpretation and application.
Aside from this, parties should watch out for pre-closing conditions and obligations that may be rendered impracticable or subject to Covid-19-caused delays. A typical acquisition agreement includes conditions prior to closing, essentially meant to ensure the seller-owners would run the business in the ordinary course. Since the pandemic has led to extraordinary times, parties should determine if business operations before the pandemic could no longer be “ordinary” post-pandemic, and whether buyers can invoke this to refuse to close the deal.
Last, sellers should assess if conditions precedent and bring down representations and warranties should be qualified. Delays caused by securing requirements and approvals from government agencies and third parties should be factored in in the transaction timeline.
Overall, M&As need not lead to a failed transaction. While there are still various factors to be considered, good preparation, proper risk allocation, strategic drafting and open discussion between the parties and their advisers are the keys to successfully navigating M&A deals.
Atty. Kristine Torres is a senior associate and member of the Corporate and TMT Practice groups of Gorriceta Africa Cauton & Saavedra (Gorriceta) (www.gorricetalaw.com). She has vast experience in various practice areas and specializes in corporate law, mergers and acquisitions, foreign investments, capital markets, and securities law.