On Wednesday the OECD announced its projection of an 11.5% reduction in UK GDP for 2020 – the worst of all developed economies and giving further credence to what has long been predicted to be a significant (but, we hope, relatively short) period of recession.
This forlorn forecast echoes the experience of those involved in corporate transactional work who have seen, since the beginning of the year when the coronavirus outbreak began to appear, a swingeing reduction in both the number of deals going ahead and their value.
Factors contributing to this stagnation include the abundance of caution being exercised by would-be acquirers; the scarcity of investment capital, particularly from private equity sources; and the general effect of the restrictions on our daily life: social distancing rendering face-to-face meetings difficult or impossible, limits on unnecessary travel, re-prioritisation of management time, etc.
The M&A market certainly looks set to be in favour of buyers for the short to medium term at least and, as we travel through the tunnel, as certain as it is that there will be light at the end, there will be opportunities along the way. This is particularly true in the case of acquirers who come out the other end in a better position than their contemporaries.
In practical terms we are likely to see more of the following going forward:
1. A much stronger emphasis on the due diligence exercise. Buyers will be keener than ever to extract as much salient information as possible about the state of the business past and present. The discovery of even slight suggestions of risk (of the type which might previously have been the subject of ‘taking a view’) will provide the buyer with an opportunity to renegotiate the terms even further in his favour. Opportunities for the buyer to walk away will abound.
2. Similarly, the disclosure exercise will be the subject of a critically important focus. Often an arduous process, in the current climate the disclosure exercise is likely to become torturous as seller teams seek to cover-off the warranties from every possible angle.
3. Greater use of deferred and/or contingent cash consideration. Those on the buy side are sure to try and negotiate away as much risk as possible from the buyer to seller. Heads of terms will provide for significant portions of the purchase price to become payable to the seller only on certain future dates or once certain performance targets have been met.
4. The use of non-cash consideration such as the issue of consideration shares or loan notes may also increase, particularly when the seller is to remain in a management role in the business for a time after completion.
5. Conversion of deals from share to asset purchases. Where proceeding with the purchase of the entire issued share capital of the distressed seller’s company is not palatable for whatever reason, buyers will have a prime opportunity to strip away any core assets from the business at an advantageous price.
6. Clauses in the purchase agreement which seek to limit the seller’s liability in terms of value or time are likely to be strongly resisted by the buyer. Where they are agreed we can expect to see higher values and longer terms becoming insisted upon.
7. Extensive, carefully-drafted warranties and indemnities in purchase agreements will of course continue to be of prime importance. Notably, the use of third-party underwritten insurance policies against breaches of warranties and indemnities, particularly where the deal involves private equity investment, has increased substantially over the last few years. This trend looks set to continue in the immediate post-coronavirus landscape given the likely disconnect between the demands of the well-positioned buyer and the extent of the concessions available to the seller.
For further information please speak to your usual Clark Holt contact.