We are all still trying to grasp how COVID-19 will affect our lives, hoping that this will be short lived disturbance. At this point it may be too early to draw conclusions of how this affect a deal flow or impact M&A transaction terms in the long run, immediate impact can already be seen and should be expected. Below we list some the main aspects of the M&A market in general and transaction specifics in the light of COVID-19:
Uncertainty and potential slowdown
While uncertainty and fears have already caused record plunges on stock markets, it is very likely that this sentiment will also spill into M&A market. It will make potential deal makers more reluctant to part with their cash and more eager to weather the storm before returning to deal making. Moreover, strategic buyers will currently be more concerned with taking care of their current businesses, supply chain issues, financing, workforce etc. than M&A transactions.
Potential for offsetting the immediate slowdown
If the virus will not be tamed for an extended period of time, we also likely to see an increased number of distressed M&A transactions. On the other hand, some economic sectors, such all online commerce, IT, healthcare businesses are likely to experience significant boost, lasting even after the current crisis is averted due to changes in social conditions and our working and live habits. Companies in these sectors may therefore be attractive to private equity investors.
Another potential catalyst for deal making is that pricing of targets will be adjusted downwards from the record valuations. Again, this should be particularly attractive to private equity investors. Transaction pricing may also shift from a multiple of historic earnings or a locked box fixed price mechanism to various earn-out structures. In the short term, the onset of quarantine has resulted in massive uncertainties around performance of contracts, debt settlement and receivables. This may cause more transactions employ net debt and working capital adjustment provision over the locked box mechanism to limit buyer’s risks.
Deal making logistics
Traditionally M&A deals and negotiations on major issues occur by sitting down in one room at some point of the transaction process. Due to existing and still tightened quarantine conditions across Europe, processes concerning deal making process, management presentations, road shows and site visits will need to be reassessed.
Due diligence considerations
COVID-19 is teaching us that certain aspects of due diligence will need to be given more importance than in the past. Such issues include: (i) assessment of contracts to evaluate force majeure clauses and parties’ rights in case of their onset; (ii) security of supply chain, its geographic spread and risks of business continuity; (iii) liquidity situation and readiness to withstand swings in liquidity’ (iv) broader review of laws and regulations, which become effective in case of critical situations – from fights afforded to contractual parties to possible governmental measures impacting the business; (v) compliance of the target with the existing regulations.
The current pandemic is an unprecedented event, with the potential to have an severe impact on businesses. Whether any of the currently signed SPAs will be affected by material adverse change (MAC) clauses is subject to specific situation and wording of MAC clauses, it is certain that MAC clauses are likely to specifically address “pandemics”/“disease outbreaks”. We would normally expect this to fall under exceptions from MAC together with other common MAC exceptions, such as negative changes in “general economic conditions” or “financial markets”. On the other hand, specifically agreed consequences of a pandemic, may very well result in a MAC.
The immediate effect of COVID-19 is that workplaces – both in private and public sectors – are moving from regular offices to working from home. While the processes and routines should adjust over time (and hopefully will not last too long), the parties to the M&A transactions should revisit the timeline for fulfilment of CPs and eventual long stop date, as it is very likely that any closing conditions relating to any governmental or other third party approvals or consents will take longer than initially anticipated. Naturally, any extension of deal terms due to the epidemic should also address the interim covenants and the response by the target to the ever-changing situation and crisis management.