Overview
For additional guidance, please refer to Steptoe's COVID-19 Resource Center.
Conducting cross-border M&A transactions is challenging at the best of the times as parties seek to successfully navigate the legal, commercial and cultural issues that arise. Undoubtedly, the disruptions caused by coronavirus pandemic will provide both buyers and sellers with particular issues beyond the norm.
We set out below an overview of issues that buyers and sellers may wish to consider in the current environment at the outset of off-market M&A transactions.
M&A transactions may take various forms i.e., strategic consolidations, distressed disposals, rescues and defensive acquisitions. In this context, certain of the issues listed below for buyers and sellers take on greater significance depending on the form of M&A being pursued.
Key Issues for Both Parties
In order to ensure the transaction progresses in accordance with the schedule, both buyers and sellers will need to consider certain practical issues, including:
Travel/Virtual Meetings
Restrictions on travel may hinder the transaction process with meetings held exclusively by video conference and/or telephone. There may be certain jurisdictions where physical meetings may need to be specifically authorized and conducted with particular precautions in place. This may prove a challenge in terms of: (i) financial due diligence, which customarily involves detailed meetings between the financial team at the target and the reviewing accountants; and (ii) compliance due diligence, which typically involves a series of fact-finding interviews between a range of management and other personnel at the target and compliance legal counsel.
Both the buyer and the seller should consider the arrangements required to be put in place for the physical inspection of original documents i.e., share registers or certificates. The parties may wish to consider the involvement of a notary or the delivery of a statutory declaration to provide appropriate comfort on the status of such documents.
Teams
Teams including professionals and employees may be impacted during the course of the transaction due to illness and/or quarantine from coronavirus. The parties will want to ensure that the composition of the teams including the advisers, have sufficient backup in place to ensure that the timetable for the project is not unduly impacted.
Marketing
An ability to market opportunities by the seller may be limited due to travel restrictions and limited opportunity for networking. If parties are willing to move quickly, then bilateral deals may be preferable as opposed to more complex sale processes such as auctions.
Onsite Due Diligence
Due diligence exercises may need to clarify the direct and indirect impact of the pandemic on the business (including the level of Government support and impact on the target's compliance risk profile and risk mitigation strategies), the customers, the suppliers and employees. Conducting onsite and/or physical inspections involving engagement with management and employers will need careful advance preparation. Depending on the type of asset, buyers may consider desktop due diligence as an interim measure and seek to increase contractual protections to address gaps in the due diligence process.
Key Issues for the Buyer
A buyer may wish to consider the following issues in the context of the proposed transaction:
Valuations and Purchase Price
Valuation of a business and/or asset is difficult at any time when there is market volatility and uncertainty.
A key consideration will be establishing the purchase price. A valuation exercise to assess the impact of coronavirus on the business to be acquired should be conducted at the outset to ensure that the buyer is satisfied with the proposed purchase price to be paid.
Any compliance risks identified as part of the due diligence exercise should be priced in to the proposed purchase price, as the target’s actual value can only be ascertained when those compliance risks and their potentially distorting impact on financial information relating to the target or its business are considered. For example, the value and viability of the target’s business may be significantly weakened by the post-acquisition prosecution of compliance-related violations that occurred prior to the transaction.
A buyer should seek to base any valuation on a purchase price adjustment. A purchase price adjustment is a more buyer-friendly mechanism as the price is determined post-closing by reference to a set of accounts of the target company made up to the closing date. The form of any adjustment may require careful analysis with regard to COVID-19 in areas such as net working capital and net debt levels.
The alternative is a locked-box mechanism which is considered to be more seller-friendly under which the purchase price is determined by reference to a set of management accounts, which may be drawn up to a date a few months prior to closing. If locked box structures are used, buyers will be keen to ensure that the gap between the locked box date and completion is as short as possible and that any issues around “leakage” from the locked box is adequately covered.
Funding
The buyer will need to satisfy itself that the project can be funded via internal cash resources. Alternatively, the buyer should ask itself the following questions: will funding be available from third parties if required? If so, what impact will this have on the expectation of the seller and the timetable? Has the buyer considered the request for vendor financing as a means of funding all or part of the purchase price? Is a share for share transaction an alternative structure to explore?
Asset Purchase
An asset sale may be attractive to a buyer as a buyer can “cherry-pick” the assets it wants and can isolate themselves from the liabilities of the target. The buyer may wish to identify areas of potential concern and ring-fence the riskier areas of the business to be excluded from the transaction. Both the buyer and the seller will need to review such pre-sale reorganisations from the perspective of insolvency legislation relating to matters such as sales at undervalues and/or preferential payments to certain parties.
Scope of Due Diligence
The buyer will want to carry out appropriate due diligence on the target in light of the coronavirus outbreak. There will be key due diligence enquiries to raise concerning coronavirus relating to the supply chain risk, reliance on government support schemes, contractual termination rights, reliance on force majeure clauses by the target and/or by counterparties including the scope of any insurance policies. The reliance and robustness of the business’ IT systems, employee health and regulatory issues and current and/or prospective litigation from counterparties, customer payment terms and the company’s outstanding debtors will also require investigation. Furthermore, changes in the target’s compliance risk profile due to coronavirus, the target’s efforts to mitigate such compliance risks and current and/or prospective investigations or prosecutions relating to those compliance risks will also need to be reviewed. The issue of enforceability and/or termination of contracts due to material adverse change clauses will need to be focused on at the outset, especially with the key contracts of the business.
Reimbursement of Buyer Expenses
The buyer may want to request that, in the event certain matters are disclosed during the due diligence process that were already known to the seller but were not disclosed to the buyer at the outset, ultimately resulting in the transaction not proceeding, the seller then reimburses the buyer for all its expenses including reasonably incurred professional fees.
Buyer Protections
In the context of the key transactional documentation, there will be greater focus on certain protective and related provisions to be included from the buyer’s perspective including:
- Pre-sale reorganisations – check if there will be a requirement to reorganise the business prior to the contemplated transaction in order to ringfence certain liabilities from the business to be acquired;
- Use of tailored warranties relating to pandemic issues concerning employees’ health and safety, data protection due to home-working, property matters arising from leasing obligations, compliance risks and IT systems including the repetition of the warranties at closing;
- Use of indemnities relating to operational and financial impact on the target in order to ensure that any loss is recoverable in full by the buyer;
- Use of earn out and/or deferred consideration arrangements in order to be satisfied on the performance of the business post-closing;
- Use of escrow accounts to provide security for the buyer in the event of any claims under the warranties and/ or indemnities;
- There may be a requirement to ensure appropriate protections are included between signing and closing which are favourable to the buyer i.e., the inclusion of specific termination rights relating to the cancellation of key contracts, identification of compliance violations or change in legislation impacting on the business and “walk away” rights for a buyer for breach of pre-closing covenants; and
- The need for appropriate third party guarantees to be provided by the seller relating to the obligations of the seller post-closing.
Reducing Risk of Successor Liability
Pre-existing conduct that continues post-acquisition is arguably the most significant category of compliance risk for a buyer in M&A transactions. While pre-closing remediation of issues identified during the due diligence process can be highly effective in reducing the likelihood that known misconduct recurs after a transaction closes, deal dynamics do not always make it possible to do so.
To reduce its future risk of liability, the buyer rapidly should take steps to remediate any issues identified during its compliance due diligence, including addressing any compliance risks posed by new business strategies and solutions formulated in response to the coronavirus. The buyer also should work quickly to implement its compliance programme and related training modules at the target and consider performing a compliance specific audit as quickly as practicable.
Depending on the extent of the buyer’s pre-acquisition compliance due diligence and any subsequent changes to the target’s business model in response to the coronavirus, the buyer may also wish to consider undertaking a post-acquisition compliance review to gain an up to date understanding of the target’s risk profile and risk mitigation efforts.
Key Issues for the Seller
Sellers in a strong negotiating position, particularly those with evidence to argue that COVID-19 will not have a lasting impact on their business, will have different issues to consider than those in a distressed situation. However, the following matters a seller may wish to consider in the context of a proposed transaction:
Due Diligence
The seller will need to be prepared to respond to due diligence enquiries including being able to access and populate data rooms which may be challenging in the current environment. The seller should consider the areas of the business which have impacted on the business and prepare appropriate due diligence materials in this context.
Disclosures
A seller will want to conduct a disclosure exercise which must include appropriate carve outs and additional specific disclosures relating to coronavirus.
Status of the Buyer
The seller will want to focus on the status of the buyer with particular regard to a cash buyer as this may place such a buyer in a preferred position. The seller may require comfort on the availability of funds via third party commitment letters as soon as the due diligence has been completed.
Regulatory Matters
The seller will also want to check at the outset if there are any particular consents or approvals that may be required with a particular buyer including merger control clearances. If this is the case, the seller will need to understand if such approvals and/or consents are likely to be obtained and the expected timeline. The increased regulation and protectionism through foreign investment control rules and tax relief measures will require clarification at an early stage in the transaction process.
Simple Structure Preference
The seller may prefer to pursue a transaction with a buyer which has a simple structure as opposed to for example, pre-sale reorganisations, schemes or arrangements that may be perceived to be more challenging.
Use of Warranty and Indemnity Insurance
If the seller or the buyer intends to rely upon a warranty and indemnity insurance policy as part of the transaction, then the availability of such a policy will require investigations at the outset. The policy will require careful review to clarify the extent and scope of any exclusion on matters connected with coronavirus including any cancellation rights by the insurers between signing and closing. It is critical for the buyer to obtain input on how to arrange the due diligence exercise in a manner that will permit the exclusions to be restricted or fully removed.
Closing and Governance Issues
The seller and the buyer will need to check board and shareholder approvals including reviewing the constitutional documents and checking that telephone/video conferences are permitted. The involvement of key personnel in the execution of documents including the use of electronic signatures must be created. The use of DocuSign and related platforms for execution of documents first need confirmation that signatures in such format are acceptable by local authorities, including third parties such as regulatory and fiscal authorities.
Heads of Terms
The above issues should be considered in the early stages of the M&A transaction process by both buyers and sellers in order to reduce the time and costs of management who may be considering an acquisition or a disposal. The above issues can be reflected in the heads of terms that should be prepared at the outset of the transaction.
