Navigating M&A transactions can be a challenge in the best of times. Unfortunately, it would be difficult to call this the “best of times” from a business perspective given the current COVID-19 pandemic. Businesses are currently facing a myriad of challenges – everything from reduced demand for services and products to cash flow shortages and workforce disruptions –therefore attempting to conduct a sale or acquisition in this environment is a taxing proposition. With that said, deal-making opportunities continue to exist, and the following are some practical guidelines to consider when attempting to pursue a transaction amidst the current pandemic.
1 – Conducting COVID-19 Focused Due Diligence.
Due diligence is a fundamental component of every M&A transaction, allowing buyers to “peek behind the curtain” of a seller’s operations and analyze key financial, operational, and legal aspects of the seller’s business. While many transactions follow a standard road map to run key issues to the ground (often expressed in the form of a due diligence checklist), prospective buyers should consider expanding their approach to address the variety of novel legal issues relating to COVID-19. These issues include (i) a target’s compliance with state/local stay-at-home orders; (ii) the applicability of employee paid leave laws to a target’s workforce; (iii) the target’s receipt of SBA and other governmental financial assistance, and (iv) any industry-specific regulatory changes (both state and federal) applicable to the target’s business. In addition to legal changes, there are a whole host of operational risks to consider, including disruptions to the target’s existing supply chain and customer base and any financial issues arising out of a target’s diminished cash flow and/or access to capital.
2 – Incorporating Legal and Operational Risks into Representations, Warranties, and Covenants.
Depending on what is discovered during the due diligence process, additional COVID-19-specific representations and warranties may be necessary to address the identified risks. For example, if a target’s workforce has moved largely offsite, a buyer might consider adding representations to the transaction agreement addressing remote access and security to the target’s IT and online data systems. Similarly, if the target has obtained SBA funding or other governmental assistance (e.g., provider relief payments made to health care providers), then additional representations and, in some cases, pre-closing covenants, may be warranted to address the use of such funds in compliance with applicable laws and any related certifications. Other areas of focus may include compliance with applicable law, collectability of outstanding accounts receivable, and the existence of relevant insurance coverage for business income loss or disruption.
3 – Adjusting the Purchase Price to Reflect COVID-19 Uncertainties.
If, after conducting due diligence and incorporating appropriate representations, warranties, and covenants in the underlying transaction documents, there is still uncertainty regarding the COVID-19 related risks associated with the transaction, a buyer may require corresponding “adjustment” mechanisms with respect to the purchase price. This could include the addition of a working capital adjustment (addressing short-term cash flow and other liquidity concerns) or a post-closing earnout (tying the seller’s ultimate payout to the post-closing performance of the business). In addition to these price adjustment mechanisms, buyers may also seek to holdback a portion of the purchase price in an escrow account with the release of such funds tied directly to the satisfaction of the COVID-19-related representations, warranties, and covenants. Sellers will likely resist these efforts but may have “no choice” when faced with the alternative of a direct reduction to the purchase price.
We hope that you find these tips helpful as you navigate the complexities of the deal process in a COVID-19 world. We fully acknowledge that each deal has its own “twists and turns” and therefore we recommend that you consult with your legal, financial, and business advisors prior to, and in the course of, engaging in any such transaction to ensure you have fully vetted the potential issues (both COVID-19 and otherwise) that could affect your deal.
