We have been struggling with the effects of the coronavirus for almost a year and it is difficult to predict how long we will remain in the restrictions caused by COVID-19. At the same time, we do not know how much the world will change once the pandemic is overcome and whether we will ever return to pre-coronavirus conditions.
M&A transactions have also been affected by the coronavirus crisis and both sellers and buyers, as well as advisors on both sides, had to adapt to changes in the conduct of transaction processes. Transactions have to be analyzed in the context of new risks related to the uncertainty and economic and social constraints caused by COVID-19.
Remote work and M&A transactions - a greater role of Virtual Data Room tools
Social restrictions introduced by individual countries meant that most of us started working largely remotely. Meetings, negotiations and business processes have moved into the virtual world. For many people, such work was almost unthinkable or unacceptable before the coronavirus. Many companies had to quickly adapt their business models, technologies and mentality to the new reality.
Transaction, legal and business advisors to a large extent quickly adapted to the new requirements. The situation is different with sellers or buyers in M&A transactions. Entrepreneurs operating in the real economy and preparing the company for sale, purchase or merger have been exposed to much greater challenges. Similarly, Private Equity and Venture Capital funds, which professionally deal with the purchase and sale of companies. While it is possible to transfer a significant part of the company's due diligence process to the Virtual Data Room, trust and the so-called "transactional chemistry" will not be born in a videoconference.
Aspects related to understanding and verifying the company's operation for sale, such as: meetings with the management board, visiting the company's headquarters or plant, getting to know key personnel and verification of business processes, still require physical meetings and the involvement of many people. Especially if the company operates in one of the traditional industries.
After talking to our clients, we see that the remote due diligence process forced the sellers to perform much more detailed analytics on the financial and business data of the company put up for sale. There are more and more types of specialized document formats in the Virtual Data Room that have not previously been included in the VDR and due diligence process - technical, graphic, production and other files.
At the same time, many company meetings and presentations are held remotely, but the buyer party reserves the right to real meetings and visits before signing the transaction. Often, recordings of visits to production plants or company seats, meetings with key personnel are recorded and also placed in the Virtual Data Room for decision makers and advisers. All this for the sake of the safety and health of the people involved, but also with an emphasis on due diligence in the verification of the company sold by the buyer and his advisers.
New requirements and areas for due diligence
According to an interview with our clients and advisers, due diligence areas in the COVID-19 era have expanded to include aspects and risks related to the pandemic. They include, inter alia:
• The overall impact of the coronavirus on the company: Understanding the changes in business processes caused by the COVID-19 crisis, including contingency planning, continuing operations, cash flow management, and cost monitoring and containment - how good is planning and how effectively is it implemented?
• Employees: Has the national / international guidelines for safe work of workers been followed, are there any risks to work safety, including documentation of possible employee complaints? Have you complied with statutory sickness benefit requirements and have there been any dismissals?
• IT infrastructure: problems with the provision and efficiency of IT resources related to remote work - is the IT infrastructure functioning satisfactorily, or are there problem areas where business operations are at risk or capital expenditure may be required to ensure sufficient reliability of IT resources?
• Cyber / data security: cybersecurity or data security issues or breaches, as well as compliance with government guidelines to protect the personal data of people infected with COVID-19 and systems, controls and processes effective under the current circumstances?
• Suppliers: problems or concerns with the company's suppliers and their continued ability to operate, including any existing or anticipated breach of contract or risk of insolvency - is the company exposed to operational disruptions as a result of supply chain difficulties?
• Customers: problems or concerns for the company's customers - reduced volumes, late payments, breach of contracts or default - are the company's cash flow and bad debts a threat?
• Insurance: business interruption or other coronavirus related risks - is there insurance coverage that may partially cover the effects of the pandemic?
• Government financial support: government assistance, funding or concessions requested / received, including for personnel - was funding or support provided and, if so, are there any conditions attached? Is the aid unconditionally / conditionally recoverable and what if these conditions are not met?
• Taxation: To the extent that any tax obligations have been deferred or a tax holiday has been obtained, what funds are available for repayment at a later date? Does the way you run your business during the COVID-19 crisis expose it to additional tax risks?
The impact of COVID-19 on transaction valuations
The time of the pandemic has already left its mark on many sectors of the economy and the consequences of the coronavirus will probably be fully known in a few years. Many transactional processes from the first half of 2020 were put on hold due to uncertainty about the future or even for fear of not being able to continue operating in many industries. Of course, there are also industries that have gained significantly in value and have been resilient to the pandemic.
In conversations with advisers and funds, however, we hear that the expectations regarding the valuation on the sellers 'and buyers' sides have drifted, causing many transaction processes to be suspended in 2020. This split in expectations translated into a decline in completed transactions in the first half of the year, but the second half showed a significant increase in M&A activity. Both sellers and buyers had to demonstrate greater flexibility in terms of transaction structure and valuation records. The negotiations on the valuation often included more detailed and precise provisions regarding the settlement of the future ("earn-out" or "retention" clauses) and much more restrictive provisions regarding possible disputes related to financial results, disclosures or accounting principles.
Legal clauses worth attention in the age of COVID-19
Force Majeure
The provisions on force majeure excuse a party's failure to perform the contract if it is caused by circumstances beyond its control, such as a natural disaster or a act of war.
Most force majeure clauses contain a list of events that can trigger the clause. Some of these lists also cover pandemics. Even those that do not specifically mention a pandemic, however, may include an event such as a COVID-19 outbreak, if the definition of force majeure used in the clause can be applied to the situation.
However, in order to invoke force majeure, the party seeking release from a specific obligation must demonstrate that all elements of the clause are met. In most force majeure clauses, these additional elements include the fact that the party was out of control and took reasonable measures to prevent or mitigate the damage. A party that cannot meet all the elements listed in the clause may not use force majeure as a pretext to avoid liability for failure to comply with an obligation contained in the M&A contract.
Material Adverse Change / MAC
Many M&A contracts also include a Material Adverse Change (MAC) clause that allows a party to terminate the M&A contract if a material adverse change affects the target activity after the contract date. MAC clauses are designed to accommodate adverse changes that are most likely to affect a given M&A activity or transaction. The law applicable to the contract may also influence whether the activation of the MAC clause is favorable and for which party. For example, a disruption due to COVID-19 may not last long enough or have consequences that are not serious enough for a specific company to justify the application of a MAC clause. Existing completed mergers and acquisitions may contain provisions that can be invoked in view of the escalating COVID-19 pandemic.
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