Checklist for Transactions in the Age of Coronavirus
While the coronavirus has slowed the pace of global transactions, the M&A market remains open. After years of dizzying growth, a slowdown was not unexpected–coronavirus (COVID-19) pandemic notwithstanding. If you are planning an acquisition right now, there are a few practical considerations worth taking into account.
1. TAKE CARE WITH VALUATION AND PRICING
The pandemic poses challenges to the valuation of target companies. It has become difficult to forecast cash flow, which is reflected in pricing. Large and exceptional fluctuations in net cash and working capital positions could make it difficult to find a purchase price mechanism that is acceptable to both parties.
Sellers are naturally looking for a fixed (or nearly fixed) purchase price that is based on historical data. Nevertheless, it is safe to expect an increase in the use of earnout mechanisms where the price is tied, for example, to future earnings.
2. AGREE ON VIRTUAL PROCEDURES, BUT MAKE TIME FOR PAPERWORK
It is a good idea to agree on virtual procedures in the SPA. Most stages of an acquisition can be carried out electronically or virtually. Due diligence reviews have been conducted in virtual data rooms for years already, and video links are a good tool for site visits, management interviews and negotiations.
However, in cross-border transactions, it is important to keep in mind that some countries require that documents be signed physically in the presence of a notary public. It is also worth reserving some extra time for preparing your own documents. Foreign notaries may require notarised documents from Finnish companies, and at least in Helsinki, notaries are currently only seeing clients by appointment.
Legal and financial reviews are easy to do electronically in cross-border deals, but environmental and technical due diligence reviews are more or less on hold in many countries due to restrictions to movement. In many industries, it is vital that the buyer’s own technical team or environmental consultant can inspect the target physically and review production on-site. Even after national restrictions are eased, travel restrictions between countries may remain in place for quite some time.
3. MAKE TIME FOR PERMIT PROCEDURES
The processing times for merger control notifications to competition authorities have gotten longer, as many people are working from home and gathering information from market participants has become more difficult. It is a good idea to leave extra space in your timetable when deciding on long-stop dates, i.e. the date by which the deal has to close before the parties are entitled to withdraw.
In Finland, we haven’t yet seen the epidemic cause delays to other permits, such as environmental permits. Environmental permitting procedures are conducted practically entirely in writing, and so are running as normal. However, as meeting restrictions continue to be in effect, expect to encounter challenges with municipal permits, particularly in smaller municipalities.
Leaving enough space in your timetable is important, particularly if the target is outside of Finland. Perhaps surprisingly, the reason for this is a technical one: it seems that the authorities in some countries have a hard time signing decisions electronically. There may even be differences between different authorities in the same country. We have already run in to a situation in which a local authority made a decision, but could not serve the decision document, because it required several signatures. It is also worth keeping an eye on processing times in target countries. Particularly in countries with a high infection rate, a lack of personnel could impact normal authority operations. For example, Spain has lifted binding deadlines for authorities.
4. BE AWARE OF INCREASED SCREENING OF ACQUISITIONS IN CRITICAL SECTORS
Many European countries screen foreign acquisitions in critical sectors, and the European Commission has called on Member States to intensify screening since the start of the coronavirus crisis. A shared screening mechanism will be adopted for the entire EU in October. This new legislation will give the authorities the power to screen and suggest restrictions to the transfer of control of a target company overseas if required by an important national interest.
In the midst of the pandemic, the authorities’ attention has moved from the defence industry and other traditional strategic sectors to the biotech and the healthcare sectors. The scope of screening is also being widened by the fact that Member States have a great deal of freedom to define ‘important national interest’. In the midst of the pandemic, some EU countries are discussing whether a strong textile industry could be considered a critical sector: fashion houses have the capacity to manufacture face masks.
5. CHECK SUBSIDIES AND LOANS FOR CLAW-BACK CLAUSES
Governmental crisis management policies could have an impact on the key figures of a target company. Many companies are now receiving state support, but some forms of support may have to be paid back later. This is worth keeping in mind in due diligence reviews during the rest of this year and the next few years to come.
6. MAKE SURE YOUR CLOSING IS SECURE
Sellers will have to accept greater uncertainty with respect to closing in the current shifting environment. In a global recession, we are likely to see an increase of financing related conditions precedent in SPAs. Sellers should also go over their representations and warranties with a fine-toothed ‘coronavirus comb’ as we can expect that sellers will more often have to renew these at closing.
MAC (material adverse change) clauses are also predicted to make a comeback. MAC clauses allow the buyer to withdraw from a deal if a material adverse change impacts the target company before closing. On the other hand, the coronavirus situation is neither a new nor unforeseen circumstance at this point.
7. REVIEW YOUR W&I INSURANCE POLICIES CAREFULLY
Exceptional circumstances raise the question of whether buyers can get insurance coverage against potential later breaches by sellers. At the moment, insurance companies are particularly focused on the financial situation of target companies and on thorough due diligence reviews, and insurance premiums are on the rise.
The parties to a deal would be wise to give some thought to what kinds of coronavirus-related exceptions to the coverage of their insurance policies they are willing to accept. Carefully targeted and justified exceptions are the best approach to avoiding disputes.