Author: Brandon Kaster
The ongoing COVID-19 pandemic continues to affect virtually all aspects of life around the world. For many companies, this means tackling the challenges of ensuring employee well-being and engagement, maintaining customers and suppliers, dealing with rapidly changing federal and state laws and regulations, reducing expenses, and planning for a shifting economic landscape. Target companies and buyers that are either just beginning, or in the midst of, an M&A transaction in this environment have these and other challenges on full display as they move through the deal process.
To assist with navigating an M&A transaction in this extraordinary environment, the list below sets forth some important topics that might become focal points in the context of a deal. This checklist is intended to be a resource for approaching some of the challenges of getting an M&A deal over the finish line in the midst of COVID-19. Of course, each transaction has its own nuances and the analysis of each situation is highly fact-specific. As such, the list below should not be viewed as a comprehensive discussion of issues/considerations that may arise.
Given current operating conditions, it is likely that buyers will expect a thorough investigation of how COVID-19 has affected the target company. The difficulty in tackling due diligence is compounded by the fact that the target company may not be able to provide information as to how the company has weathered similar conditions in the past – as such information may simply not be available. Further, on-site visits and in-person meetings may be imprudent or prohibited by state/local regulations. Buyers and target companies might consider remote diligence conferences and carefully tailored representations and warranties to address these issues.
Material Adverse Effect (“MAE”) and/or Material Adverse Change (“MAC”) provisions are typically included in the core purchase document in M&A transactions to allocate risk with respect to substantial events or consequences that could have a long-term and adverse impact on the target company’s business. Though the impact of COVID-19 is business-specific, buyers and sellers should endeavor to negotiate explicit MAE/MAC language, including whether the MAE/MAC definition specifically refers to COVID-19 or, more generally, pandemics, epidemics, disease outbreaks and/or health emergencies.
Because the extent of COVID-19’s impact remains uncertain, it may be difficult to properly value the target company at the time of signing a transaction – especially if there is a delay between signing and closing. This issue can be addressed in a variety of ways, including the use of an “earn-out” if the buyer and seller cannot agree on the value of the target company. Earn-outs generally call for future consideration to be paid to the seller in a transaction upon the achievement of certain thresholds or other metrics relative to the business. Though earn-outs are one method to bridge the valuation gap in an uncertain economic environment, it is important to note that using an earn-out approach can result in complex and challenging negotiations. Further, and because of the complexity of drafting, earn-outs have a potential for disputes later on.
Buyers and/or sellers looking to obtain representation and warranty insurance as a source of post-closing indemnity protection will need to focus on how exclusions and limitations will apply as a result of the virus. Because COVID-19 is now a “known risk,” it is probable that insurers will specifically carve-out COVID-19 related losses from policy coverage. As such, it is vital that the exclusions set forth in the representation and warranty insurance policy be carefully addressed with counsel. Further, parties to an M&A transaction should expect that representation and warranty insurance providers will request substantial virus-specific and/or ancillary diligence to underwrite the policy. As a result, this may delay or lengthen the underwriting time needed to finalize the policy.
If a deal is structured as a signing followed by a closing, the parties should carefully consider whether exceptions should be made to the interim operating covenants, which typically require the seller in a transaction continue to operate the target company in the “ordinary course” until closing. Given the rapidly changing economic environment, a seller may need to take actions that would not be considered “ordinary course” to minimize the negative effects of the COVID-19 outbreak on the business. In such circumstances, it may not be realistic or feasible for the seller to obtain a buyer’s consent before taking this action. Buyers and sellers should work together to negotiate reasonable exclusions to interim operating covenants that give the target business flexibility to respond to current challenges, while maintaining the buyer’s need to be made aware of significant deviation from normal operations.
Disruptions caused by COVID-19 (including travel restrictions, office closures, social-distancing, and other government regulations) may complicate or delay closings of M&A transactions. For example, many state and county filing offices have been closed to the public or have long delays. Further, in-person filings in many locations have been suspended entirely. This affects closings that require a certificate to be filed (such as a certificate of merger) or a certificate to be obtained (such as a good standing certificate). In addition, third-party consents and signatures from officers/directors may take more time than usual. To address these realities, buyers and sellers should coordinate with the applicable filing offices early on in the transaction and build likely delays into the closing schedule. Further, the process for securing required consents and collecting signature pages should be started as early as possible.
While there are challenges and hurdles to getting an M&A deal over the finish line right now, it is not impossible. The Corporate Group at Levenfeld Pearlstein has represented several clients in deals that were negotiated or closed during the pandemic. To learn more about the latest developments, follow along with our Daily 3.