The COVID-19 pandemic is changing the approach to M&A deals. As companies are reorienting their value chains and traditional business models are changing, an increase in distressed asset allocation and smaller transactions is expected. The pandemic also updates the content of pre-investment due diligence research – it became necessary to use a greater number of sources of information to confirm assumptions and analyze not only financial indicators. People began to Use VDRs. What is that – read here .
Main Trends in Pre-Investment Research
At the heart of any M&A deal is a thorough financial analysis. However, the corona crisis has led to an increase in the level of uncertainty regarding both historic and forecast data. Such an analysis, in combination with the study of forecasts and parameters of similar transactions, helps to reveal the influence of the factors underlying the results of business activity and to separate the effect of those related to the pandemic. Analysis of the forecasts will require a closer examination of the underlying assumptions, factors affecting revenues and expenses, the order book, and market trends. Let’s stop at three:
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Flexibility and depth. In conditions of turbulence, financial models should be more flexible, and take into account a larger number of variable parameters for consideration of combinations of scenarios of the development of the market situation. Today, digital transformation and telecommuting, along with the spread of online commerce, make information technology and security among the most significant indicators of a company’s value. However, in today’s environment, only assessing the adequacy of IT strategy, architecture and management are not enough for the business model and future growth. We are increasingly observing how the assessment of data security and resistance to cyber security threats in the context of the value of the transaction is becoming a key component of pre-investment research – due diligence.
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Preliminary assessment. The impact of a series of global lockdowns has demonstrated the importance of evaluating an investee’s supply chain before entering into M&A deals. After all, such issues as security of supply and substitution options become a key factor in mitigating business destabilization after the conclusion of the agreement. In addition, such analysis also allows for the identification of potential benefits that can be realized after the conclusion of the agreement due to the optimization of procurement or category costs.
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Technologies at service. With restrictions on travel and site visits due to the pandemic, we are seeing a trend towards the use of drones and computer technology as an alternative to physical inspection of fixed assets and stocks in sectors such as agriculture, energy and natural resources, and transport and infrastructure.
How the Flow of Transactions Changes
Agreement negotiations are currently often delayed. First of all, this is due to a gap in the expectations of the parties regarding the value of the transaction. Even sellers of distressed assets typically find it difficult to accept a deal price based on business life cycle days. In today’s environment, more and more deals rely on performance-related pricing mechanisms after the deal closes, such as a deferred reward component. However, it is important to carefully consider the formulation and calculations on which such mechanisms are based. The more complex the mechanics, the higher the probability and risk of disputes between the parties at the time of payment.
The crisis affected not only the procedure for evaluating deals but also the process of value protection. We are talking about such documents as the share purchase agreement (SPA). During periods of uncertainty, deal negotiations often go more slowly as each party tries to find what they believe is a fairer way to share the risks. Although the use of material adverse change (MAC) clauses, which allow one or both parties to terminate the agreement under certain circumstances, is typical of DPAs, we are seeing MAC provisions being excluded time and time again due to the crisis.
Locked box and hybrid locked box closing methods are becoming more and more popular among sellers. This approach, in contrast to completion accounts, provides greater certainty regarding the price of the transaction but requires a clearly defined perimeter of the transaction. Pilih involves the obligation of the seller to carry out the “ordinary business” of the business on behalf of the buyer between the signing of the agreement and its completion.
Implementation of Activities in a Period of Uncertainty
So what does “business as usual” look like in a time of unprecedented uncertainty like a pandemic? Buyers should carefully consider the pros and cons of a locked box and take into account the ability to recover damages and losses due to a possible outflow of assets.
The choice of the mechanism for concluding the agreement will largely depend on the relative strength of the negotiating positions of each of the parties. Sellers often prefer the reliability of a locked box, while buyers find that completion accounts provide greater protection by adjusting for events that affect the price after the fact.
We need to get used to the idea that mergers and acquisitions will carry the legacy of the crisis from the COVID-19 pandemic for some time to come. The pandemic has complicated the dealmaking process for at least the next few years, prompting buyers and sellers to rethink their approach to evaluating, negotiating, protecting, and realizing deal value.