The year 2020 has had an adverse effect on economies worldwide. The COVID-19 pandemic has been named one of history's most challenging crises – more severe than World War II and the Great Depression. Given the extraordinary uncertainty as to the pandemic's duration and impact, financial prudence has become the new normal. Corporates have become cautious with regard to liquidity flow and many are unsure about proceeding with M&A deals, be they ongoing or in the pipeline. Boeing recently walked away from its $4 billion deal with Embraer's aviation business due to the disproportionate impact that COVID-19 has had on the jetliner market. However, on the other hand, Accenture has acquired Byte Prophecy, a Big Data analytics company, to address the increasing demand for AI.
Companies face varied and unique challenges and the actions undertaken to combat these will determine the continued viability of their business. In the coming months, various M&A practices are expected to emerge based on market demand and the extent of the pandemic's impact on each sector and jurisdiction.
Approaching M&A now and in future
To execute M&A transactions amid this economic crisis, companies may consider the following approach.
Bridging valuation gap
The seller-friendly market is long gone; one of the principal consequences of the COVID-19 pandemic has been the lowering of sellers' expectations. As such, M&A transactions must be structured in a manner that has long-term value for both parties. In this regard, the most common valuation methodology uses multiples of the target's 12-month earnings before interest, taxes, depreciation and amortisation.
However, this methodology is no longer a means to predict an entity's future performance due to the prevalent uncertainties in the market. Thus, the key to bridging this valuation gap is to invest in tranches, with each investment tranche being based on separate valuations. For instance, a hybrid rollover structure could be adopted (ie, 70% of the target's equity could be acquired on closing and the remaining 30% could be acquired two to three years from the initial closing date based on a formula that considers the target's future performance).
Reviewing transaction documents
M&A transaction documents must be swiftly adapted to reflect the circumstances brought about by the pandemic. In this regard, the following clauses will require significant negotiation and must be crafted with the utmost diligence.
Materially adverse changes or events
The occurrence of a materially adverse event (MAE) gives the buyer the right to walk away from an M&A transaction. Parties may consider the inclusion (from the buyer's perspective) or exclusion (from seller's perspective) of events such as border closures, lockdowns, pandemics and other events that may frustrate the completion of M&A transactions.
Long stop dates
In certain cases, it is unlikely that an MAE would, in itself, render an M&A transaction impossible. To avoid such cases, parties must pay attention to clauses such as long stop dates (ie, the postponement of the closing date of an M&A transaction to a mutually suitable date when the situation in question is remedied). When determining a long stop date, factors such as remote working of government officials and delays in obtaining consents and approvals should be considered.
Obtaining warranties
In order to assess the risks associated with an MAE, the buyer may consider obtaining detailed warranties and a disclosure letter from the seller. The seller may have to qualify the warranties to the best of its knowledge (which may have to be carefully defined). The need for warranty insurance must also be negotiated.
Deferred payments
The payment of consideration in a merger or acquisition may be deferred over tranches which are mutually agreed between the buyer and seller. Further, the payment of consideration may be adjusted to key business parameters to ensure deal and value certainty. For instance, the buyer could pay 80% of the purchase consideration on closing the M&A transaction and the remaining 20% could be contingent on or deferred to after closing. In this respect, the relevant regulatory aspects need be complied with.
Embracing technology
COVID-19 has swiftly shifted the world from physical to virtual. In many jurisdictions, governments have issued new legislation eliminating the need for physical meetings and enabling shareholders and directors to meet using electronic means, such as videoconferencing.
The execution of contracts using digital signatures is also on the rise. Parties must therefore adapt to these changes by making suitable arrangements to procure digital signatures and convene meetings and negotiations using electronic means.
In these trying times and beyond, M&A is expected to increase as corporates seek to boost their resilience. Further, companies may consider acquiring start-ups that are facing financial pressure but have innovative ideas and resources that are attractive to a strategic buyer willing to move quickly with respect to deal structures. In view of the extraordinary uncertainty brought about by the COVID-19 pandemic, businesses must re-evaluate their corporate strategies to enable them to survive this crisis by implementing financially savvy deals.
As there is no M&A rule book for avoiding distressed deals, parties must be creative and flexible with their deals to allocate the valuation, financing and legal risks among themselves. Parties must look beyond the horizon to assess how their industry will evolve and plan their integration in view of this. Companies' readiness to prioritise potential themes, expand their outlook and be proactive will allow them to execute M&A transactions in an opportunistic manner.
