It is no surprise that since the coronavirus epidemic took hold back in March, we have seen a downturn in the number of businesses pursuing acquisitions, with many agreed deals being put on hold. However, as long as buyers proceed with caution and refocus in some important areas, there will be good opportunities in the post-lockdown period.
Here are five areas that buyers should focus on.
Always a central stage of any acquisition, the due diligence process should alter as buyers focus their attention on the commercial and practical impacts of coronavirus on the target. They should scrutinise its:
› Business continuity planning
› Ability to function remotely
› Ability to maintain payment of its debts as they fall due
› Ability to control operating costs
› Future financial projections
› Key contracts and the termination or suspension rights of each party (including force majeure clauses)
Warranties and indemnities
Warranties and indemnities are often a subject of much debate between buyers and sellers as they allocate post-completion risk. In the present climate buyers are likely to require additional warranties and indemnities relating to coronavirus specific risks such as the status of key contracts and disaster recovery plans. This will transfer liability onto the seller if there are issues in these areas that effect the operation or performance of the target post completion.
Purchase prices are typically structured so that the buyer pays an initial proportion of the price on completion. This is followed by a post-completion price adjustment using a pre-agreed completion accounts process, which takes into account the actual levels of cash, debt and working capital at completion.
The remainder of the agreed price is then paid in deferred payments that are payable in instalments post completion. These can be linked to the performance of the business during the payment period, known as earn out payments.
The completion accounts process will be harder to navigate now and we expect to see a rise in the use of deferred payment and earn out price structures, with the level of completion payments reducing. Paying less on completion and linking the purchase price to the future performance of the business is an effective way for buyers to minimise the financial risk of an acquisition.
For buyers seeking finance to help fund their acquisitions, there will be significant additional hurdles to face. Lenders and investors will have similar due diligence concerns to buyers about the future prospects of the target and will be more risk averse. They are likely to have more stringent lending and investment criteria, possibly including additional security requirements that reflect a more cautious approach.
Deals are will take more time to negotiate and conclude in the current climate.
The volatility of the market will mean that valuing businesses becomes more complicated, with even wider gaps between the valuation of buyers and sellers than normal. The due diligence process, lengthy under usual circumstances, will become more thorough and take longer as buyers quite rightly take a more cautious approach.
The computation of accounts and management accounts will be more complicated and require extra time and scrutiny. Lenders or investors will have more stringent requirements as they also adopt a more cautious approach. The legal documents will take longer to negotiate as a consequence of a more complicated and protracted process.
Put simply, everything is likely to take more time than it would normally.
Buyers should undoubtedly be more cautious about approaching acquisitions post-lockdown than they were before However, if they focus in the right areas and have a good professional team around them, there is no reason why buyers should not look to get deals done.
Here are five recommendations for buyers exploring acquisitions:
1. Pay extra attention during due diligence to the commercial and practical implications of Coronavirus, such as business continuity planning, ability to pay debts and how well they manage operating costs.
2. Consider whether you need extra warranties and indemnities for Coronavirus-specific risks, such as disaster recovery plans and the status of key contracts.
3. Evaluate the purchase price structure – it may be better to pay less on completion and link the price to future business performance, which minimises your financial risk.
4. Be prepared for lenders and investors to ask for additional security requirements as they adopt a more cautious approach to funding acquisitions.
5. Expect deals to take far longer than normal to negotiate and conclude, as every stage will rightly be subject to more scrutiny from everyone involved.