Covid-19 Corporate Update March 2020
In this article, we consider the geopolitical climate and the impact of COVID-19 on M&A transactions.
In times of uncertainty, all service providers, across industries, want to help their clients by offering advice and guidance. Law firms will often focus on the nuances in transaction documents and the associated areas of concern for interested parties. Unlike traditional law firms that are limited to analysing blackletter law and reporting on the same, our team at Avonhurst is determined to assist our clients through the current challenges posed by the Covid-19 in the same holistic manner in which we represent our clients through transactions at any other time: by providing our clients with a full suite of political strategy, legal advisory and capital services. Through our Political Strategy Services team, we offer our sophisticated capital clients clarity in an uncertain geopolitical and macroeconomic climate; our Legal Advisory team helps to analyse legal risk and provides certainty in executing associated transactions; and our Capital Services team will help introduce liquidity where opportunities require additional sources of capital.
Avonhurst exists to help address the changing needs of sophisticated capital; we were designed by clients for clients and we are here to help you!
Covid-19 is rightly dominating the agenda for governments, communities and businesses globally. Currently, many private equity funds are primarily focusing on managing portfolio company operations and shoring up their finances for what could be a prolonged period of disrupted trading.
Market dislocation, while presenting risk, also creates opportunity for prospective buyers who can access finance. The right time to unlock these opportunities remains the key question. We set out four key areas for prospective buyers to consider alongside this.
A sustained slowdown in business activity will see lower leverage in M&A transactions with more creative debt and equity solutions required to execute them, including through co-investment.
· Lenders may be more willing to fund transactions in Covid-19 resilient sectors, such as food chain supply, healthcare solutions and some tech deals.
· Buyers may need to be prepared to increase their committed equity for transactions generally, with the potential to refinance (and increase leverage) when the market improves.
· Target businesses may require additional financial support that may need to be factored into any financing. Delays in supplies or customer payments will adversely impact a target business’ revenue in the near term.
The impact of Covid-19 on a business’ operations will require an increased focus on certain areas in a buyer’s due diligence.
· A target’s business continuity plans should be stress tested- are these adequate over the longer term, or do they envisage no more than 1-2 months of disruption? Is the business overly reliant on key individuals, without whom, the business would not function effectively?
· Insurance policies will typically not cover risks to the target which are known or "reasonably foreseeable" at the time when the insurance was taken out. Business interruption policies and travel insurance are prime examples.
· Due diligence will need refreshing to avoid “static analysis”. The epicentre of the Covid-19 outbreak is likely to move and it could return to previously contained centres. Operations in jurisdictions which are currently less affected by it, such as Africa and South America, may present a greater investment risk in the near term.
Continued market turbulence will result in lowered valuations (discounted prices) for assets.
· Buyers will be better placed to insist on the use of completion accounts, which allow for a post-completion price adjustment, as opposed to a fixed equity price achieved through the locked box mechanism (requiring the buyer to take financial risk on the target business from an historical locked box date).
· Buyers will also seek earn out arrangements (to meet differences in valuation and interrupted trading) and deferred payments (to better manage their own cash flow).
The Covid-19 crisis will see governments adopt more protectionist tendencies in their responses and increased public sensitivity to “foreign” takeovers. However, government response will need to be balanced against the urgent need to secure employment and growth opportunities.
· Conditions precedent, whether antitrust/regulatory or commercial, are likely to take longer to satisfy given disruption to the workforce of governmental/regulatory authorities and commercial counterparties.
· Protracted transaction timetables will see more buyer focus on the range of contractual protections to preserve the value of the target business in the period to completion (operating covenants and the inclusion of material adverse change (MAC) clauses and repeated commercial warranties at completion).
· It may not be possible for a target business to consistently carry on “in the ordinary course” up to completion. A more collaborative approach will be required with sellers, including through enhanced information rights and input on the target’s response strategy to manage any sustained/future outbreaks (where applicable, subject to gun jumping requirements).
Avonhurst is a political and legal advisory firm that serves the need of sophisticated capital with services ranging from research, consultancy and structuring to deal execution.