WHAT SHOULD YOUR MEDIUM TO LONG TERM STRATEGY BE?
The COVID-19 pandemic has seen an unprecedented, global crisis pervade all areas of life. Whilst our thoughts must continue their focus on those around us who have suffered and continue to suffer and those who continue to put themselves in harm’s way to treat those in need it is also true that political, economic and social welfare uncertainties have resulted undoubtedly in a downturn in transaction activity. As the repercussions of the COVID-19 pandemic increase what are the steps that businesses can take in circumstances where access to capital and the right opportunity present themselves? Consequently, how will sellers of companies and businesses respond?
From the perspective of the buyer it will wish to determine the risks associated with the target business and from the perspective of the seller it will be obliged to present the business in a particular, expected form on completion. As such, the impact of the COVID-19 pandemic will most likely alter the manner in which both parties consider their obligations and manage their risk going forward. More particularly, parties to a transaction will need to consider more carefully just how risk is apportioned between them.
Here are a few approaches to consider within the framework of a traditional corporate acquisition and disposal:
MATERIAL ADVERSE CHANGE (‘MAC’) /MATERIAL ADVERSE EFFECT (‘MAE’) PROVISIONS and FORCE MAJEURE CLAUSES:
MAC/MAE provisions are intended to capture events which occur between the date of signing and completion of the transaction. They are of a type that are considered to be unforeseen and which have a considerable, adverse impact on the target business, most likely resulting in a negative impact concerning the value of the target. At their heart they seek to provide a foundation for a buyer to terminate a transaction but which, despite their intent, can often be difficult to achieve. Consequently, such clauses will undoubtedly receive more acute treatment. Moving forward, parties will be required to include express wording to address “pandemic risk” or” epidemic risk” for that matter in very general terms but parties are well advised to ensure that such clauses are not too broad in their scope but rather more specific and exacting to avoid uncertainty. In the alternative and from a practical perspective it is likely that parties will also wish to ensure that no timeframe exists between signing and completing the transaction. Prevention, severing the chain, is an immediate solution to the problem.
Commercial contracts will more often than not include “force majeure” clauses that typically address the fact that one party (usually the provider of goods or services say) will be excused their performance of the contract if failure to perform their obligations is caused by circumstances outside of their control. Like MAC/MAE clauses in an acquisition agreement force majeure clauses contained in commercial agreements which surface as part of due diligence will require careful examination to determine the existence of such provisions in the first place and their veracity if existent.
LEGAL DUE DILIGENCE:
The challenge of conducting (and for that matter addressing on the part of the seller) a due diligence exercise is considerable presently. The ability to undertake physical inspections of assets and premises and person to person meetings is, at the time of writing, largely impossible. Information gathering exercises that can however be undertaken remotely will doubtless require more particular investigations into areas of the target business including interim financial reporting, contractual financing arrangements, customer payment terms, customer and supply chain agreements, regulatory changes as a consequence of the impact of the current crisis, business continuity plans, target terms and conditions of business, business interruption insurance and insurance claims generally, health & safety and employment matters for example. Perhaps most importantly of all at the present time and into the medium term will be the need to investigate the solvency of the target.
Buyers will wish to ensure that the ongoing stability of the target business is secure and will wish to identify areas of exposure as a consequence of the COVID-19 pandemic. Sellers are well advised to consider areas of concern as highlighted above with a view to taking such steps as can practically be taken to improve the business not just for the purposes of sale but to secure its financial integrity going forward anyway in the event that no sale is performed.
REPRESENTATIONS and WARRANTIES:
Parties will wish to consider representations and warranties to be included under the terms of the acquisition and disposal documentation with extreme care. In circumstances where documentation is already in circulation the seller will need to consider whether or not it is in breach of warranty at this time given the speed of the current crisis and its impact. This is because warranties and representations are repeated on completion in most instances. If documentation is not yet in circulation then the buyer will need to consider carefully the nature and extent of warranties and representations sought from the seller and the seller consequently will need to consider carefully what disclosures it may need to make in light of COVID-19 pandemic warranties for example and for that matter taking into account the impact that the crisis has had on the business as a whole.
It is quite likely that given the severe impact on business in general terms by the COVID-19 pandemic that buyers may seek to require sellers to provide indemnities concerning areas of the business that are of concern to the buyer. These indemnities may be corporate or personal as the case may be.
Buyers may seek to agree payment for the target over a term. Buyers may also wish to agree to the provision of a retention upon completion too. Still further, buyers may wish to agree terms with the seller which introduce an element of the overall price in the form of an “earn-out” to paid to the seller say 12 months after completion and based upon the financial performance of the target business during that time. Such tactics are designed to be deployed by the buyer of course to manage their financial risk and financial exposure on and after completion.
However, at the outset of proceedings parties may wish to agree the treatment of the purchase price before any substantive work is undertaken. Buyers may wish to ensure that completion accounts mechanics are introduced to the documentation which to all intents and purposes delay the valuation of the target business which as a consequence allow for uncertainty and impact on the target to be taken in to account in terms of pricing. Sellers on the other hand may wish to agree an alternative form of “locked box approach” whereby pricing is set but where only certain treatments are undertaken concerning cash and working capital for example. In either case the outcome will be that a price adjustment occurs in favour of one party or the other.
If you have any questions about how to safeguard your acquisition or disposal or the options available for your business please contact Andrew Morgan, Partner and Head of Corporate, by email: email@example.com or telephone 0207 644 6303 or contact him on LinkedIn.