Managing M&A in an Economic Downturn


We are currently experiencing a global economic downturn triggered by the COVID19 pandemic. This has affected the entire commercial and finance world. M&A activity still continues though, even in these uncertain times. Some businesses seeking an exit are accelerating that process. Buyers with strong balance sheets can acquire businesses at better valuations. Pádraig Walsh from the Corporate and Commercial practice group of Tanner De Witt reviews the issues that arise when conducting M&A in a downturn.

Negotiating the Share Purchase Agreement

Even in a pandemic, businesses can strive to grow and survive through acquisition. Here are some points to consider when embarking on deals:

Valuations: Most valuations are performed on either a discounted cash flow basis or on a peer comparison basis. Discounted cash flows are based on historic revenues that are projected to estimate future revenues. However, last year’s financial performance is unlikely to be an appropriate measure for the economic future we are presently facing. Peer comparisons are also difficult to justify at the moment. This uncertainty in using traditional valuation metrics is compounded by the different expectations on both sides. Sellers may still believe or hold out for valuations based on historic performance. Buyers know this is not sustainable. The longer the pandemic continues, the more that buyers’ views will hold sway. In the meantime, factor in more time for discussion and negotiation before deal terms are agreed in principle.

Due diligence – employment: Since the beginning of 2020, many businesses have faced a multitude of employment concerns. Employees have been made redundant, terminated or requested to take unpaid leave. Employers have had to address novel health and safety issues. All these complicated employment matters needed to be properly managed in accordance with applicable laws. There is a significant long-tail risk to these issues, that could continue for quite a significant period after closing. These matters must be carefully considered in due diligence. Some issues could be addressed in warranties, indemnities, or post-closing undertakings. Some issues may be red flags and walk away points.

Due diligence – contract reviews:Normally in a contract review for due diligence, the primary focus is on change of control issues. It is now crucial to examine termination rights as well. Are core suppliers locked into the business, so there is a source of supply that can be relied on to continue? Is there the opportunity to terminate and exit contracts that are unprofitable and burdensome? Also, what circumstances allow for suspending contracts because of force majeure reasons? The due diligence review of contracts is much more consequential and significant in the current climate.

Money: The most ideal outcome for a seller is to receive 100% of the purchase price unconditionally on closing. That seems inconceivable for most acquisitions now. Sellers can expect that a significant amount of the purchase price will be placed either on earn out (if key people will stay in the business), or on deferred consideration in instalments. Deferred consideration will have conditions attached. If those conditions depend on financial performance, sellers must carefully consider whether that financial performance can be achieved. This is particularly important in circumstances where there will be a new owner of the business, and the ability of the key people to influence financial performance may be challenged.

After signing, before closing

Here are some issues to address in the twilight zone between signing and closing:

Third party consent / approval: Given the closure, remote working and operational challenges faced by regulators and approval bodies, more time should be allowed to obtain third party approval for a change of control or other regulatory approvals.

Long stop date: A long stop date before a hard closing will need careful consideration. Failure to close by a long stop date could give an intended buyer the right to walk away from the deal. This possibility may be more attractive if economic circumstances remain challenging. Sellers should ensure there is a generous period allowed for a long stop date, and both parties should be prepared to negotiate in good faith if a deferral of the long stop date is needed.

Material Adverse Change (MAC): A MAC clause can empower a party to cancel the deal, provided that there has been a material adverse change to the business between signing and closing. While this may appear to be a significant risk, generally established principles help to understand how this provision is applied. The material adverse change must be in relation to circumstances that were not known when the agreement was signed. Also, sellers will seek to carve out from the MAC clause any material adverse change that applies generally across the economy, as opposed to the unique case of the company and its business. We have also seen extended MAC clauses that expressly exclude pandemics or similar events being considered a material adverse change.

After closing

If closing has occurred, it does not mean that the seller is out of the woods and in sunnier climes.  Sellers should review the warranties given in the Share Purchase Agreement. Were the promises and assurances made about the business correct? How much of any subsequent deterioration in the business can be traced back to circumstances before closing? How much knowledge of those circumstances can be imputed to the sellers?

These are all critical issues in M&A at the moment. The bottom line is that more time, more negotiations and more creativity are needed. Once that flexibility is allowed though, there are still deals to be done, and we are ready to help.

Pádraig Walsh

If you would like to discuss any of the matters raised in this article, please contact:

Pádraig Walsh
Partner | E-mail
Eddie Look
Partner | E-mail
Tim Drew
Partner | E-mail
Edmond Leung
Partner | E-mail

Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.