19th March, 2020 by Oliver Pritchard
The COVID-19 virus is impacting on pretty much everything at the moment, and this includes corporate transactions. We have identified our top 5 issues for anyone who might be undertaking (or in the process of negotiating) the sale of a business or company during this challenging and uncertain period.
Some buyers will obviously want to reconsider whether or when to proceed with the transaction in the current climate.
Parties who have already exchanged contracts but have not yet completed will want to review their agreement, and in particular any MAC clauses.
Broadly speaking, a MAC clause may allow a buyer to terminate the contract and withdraw from the transaction prior to completion on the basis of a material adverse change affecting the target business. Whether the COVID-19 outbreak constitutes a material adverse change will depend on the particular wording of the contract in each case; the actual and/or likely future effect of the virus on the business; and the timing of exchange of contracts. If the parties were already aware of the potential impact of the virus before exchange then it will be more difficult to rely on the MAC clause to withdraw from the deal.
Where the parties are planning a split exchange and completion and have not yet exchanged contracts, the buyer is likely to want to include some very clear wording within the MAC clause to ensure they can withdraw if it becomes clear before the completion date that the effect of the virus on the target business is more serious than currently anticipated. Conversely the seller may want to try and expressly exclude epidemics and pandemics from the MAC clause arguing that this is now a known event that should be factored into the buyer’s decision to proceed at the outset. As ever the final position will depend on the negotiating position of both parties.
Both parties might still wish to try and complete a deal but cannot agree whether the original purchase price remains sustainable, perhaps because it is too early to assess the full impact of the virus on the target business. In this case, it might be possible to agree a mechanism for deferring part of the purchase price known as an “earn out”. Typically the sale agreement would contain a formula for determining the amount of deferred consideration depending on the target business’ profitability during the first year or so of trading after completion of the sale. If profits are badly hit by the virus then the buyer ends up paying less after completion, while if the impact of the virus turns out to be less serious than expected the buyer pays more.
The seller will want to include protections in the contract to try and prevent the buyer from artificially suppressing or diverting profits in order to pay less under the earn out.
The tax treatment of earn out payments can be tricky so always take specialist tax advice.
In addition to the usual legal due diligence which is undertaken in respect of the target business, most buyers will want to fully understand the likely impact of COVID-19 before proceeding with the transaction. This will depend on the type of business, but a prudent buyer should consider asking a seller about:
The legal and financial due diligence processes should focus on the target business’ ability to manage the current circumstances, and the financial impact of doing so. It will be vital for the buyer to know that the target will be able to preserve its status of solvency in light of any liquidity issues. All of the issues which are identified in this stage can then be dealt with through the negotiation of warranties and indemnities in the usual way.
The warranties given by the seller, and the disclosures made by the seller against those warranties, are a key part of most company and business sales. The impact of COVID-19 could include:
Many share and business acquisitions are funded by third party financing. COVID-19 is likely to impact on acquisition financing, such as bridging loans or long-term debt, both in terms of availability and repayment terms. Even in normal circumstances buyers will usually want to avoid committing to any legally binding agreements unless and until they have secured unconditional funding, but in the current climate particular care is needed to avoid becoming bound into an agreement which can no longer be financed.
For further information, or if you have any questions or concerns, please contact [javascript protected email address] or your usual contact within the Corporate and Commercial team.
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