The COVID-19 pandemic has had a huge impact on the M&A world. Although it is too early to evaluate the impact on the level of activity, there is no doubt that stakeholders at the various stages of transaction today will have to take a step back and review the entire transaction. Depending on the stage they are in they will have to reevaluate all risks and pay special attention to the following elements:
Material Adverse Effect Clause
This standard clause allows the buyer to pull out of a transaction if an important change with negative impact occurs, as defined in the transaction agreement. Whether COVID -19 is an important change with negative impact in terms of a transaction agreement will depend on the wording of the agreement.
Purchase Price Adjustment Clause
Purchase Price Adjustment Clause
A price adjustment clause allows the acquisition price to be modified according to negotiated parameters. Typically, normalized working capital is required upon closing, otherwise the purchase price is reduced. In the current context, what is normalized working capital? How much impact will the pandemic have on it? A clear definition in the agreement will avoid any confusion. Also, it appears evident that the crisis will cause a gap between the perceived value, between the seller and the buyer. In order to bridge this gap, stakeholders will possibly have to use earn out clauses.
Interim Operating Considerations
It is standard procedure that, between the signing and the closing of a transaction, the buyer requires the seller to operate in the ordinary course of business, to protect its value. What is the impact of the foregoing on these considerations? This crisis will cause tremendous pressure on the working capital and liquidity of the seller, but what part of this can be attributed to him or her? Again, to avoid confusion these considerations must be clearly defined in the agreement.
This component is critical to decide if a transaction will close. Volatility caused by the current crisis can make financial projections and supporting assumptions almost impossible to prepare or to validate. In this context, additional guarantees and representations by the parties can bring additional comfort, as would additional information provided by the seller on a timely manner. In addition, the buyer could subscribe to an insurance on warranties and representations made by the seller.
Purchase Price Payment
In the current context, and for some industries more than others impacted by the crisis, liquidity will be impacted and financing more difficult to obtain. In such context, sellers will want additional assurance that the purchase price will be paid. Escrow agreements can be a solution to minimize the risk of default.
It is clear that COVID-19 represents an opportunity for some, especially in light of the fact that the Bank of Canada reduced its policy interest rate by 1.5%. This being said, in a context of uncertainty and volatility, it is strongly advised to put emphasis on due diligence and the other clauses mentioned above, in order to minimize risks associated with the contemplated transaction.
Do not hesitate to contact one of our advisors if you have any questions about M&A transactions.