Some existing transactions have continued but a target company’s business performance and trading risks in the new climate have now taken centre stage. Many new deals are on hold while companies (including targets and potential trade buyers) focus upon shoring up their own businesses whilst re-evaluating investment opportunities to ensure they offer short and long-term sustainability. Private equity investors are also taking time out to ensure their portfolio companies have appropriate support before they embark upon new investments.
Whilst the transition to lock-down and the uncertainty created by current events has undoubtedly led to a marked reduction in M&A activity, the corporate team has closed 10 transactions for clients in the past few weeks. We continue to actively advise on around 25 ongoing transactions and have received many new M&A instructions since the lock-down commenced. Given that we are ranked third by Experian for the number of UK deals in 2019, this is a significant reduction on typical activity levels, but there are still deals being done and new deals starting.
We cannot be sure whether mid-market M&A activity levels in the UK will bounce back quickly, or whether a return to a more active deal landscape is going to be long and slow. For any deals ongoing during the pandemic and indeed for those deals that come online in the near future, the risks and framework for deals have changed.
- Due diligence: In the short term due diligence will focus more closely on strategies being deployed by the target to cope with Covid-19, looking closely at contracts with supply chain and customers, measures taken to furlough staff or change working arrangements, availability of finance and business continuity. In the longer term, these issues will remain important and how a business copes today might stand it in good stead during any future examination as part of due diligence. For many years, legal due diligence and most other due diligence has been undertaken without needing to access physical site locations and we expect this to become even more pronounced;
- Pricing structure: Buyers will want to de-risk the price. There are likely to be more deals on deferred terms and/or involving earn-outs (which can be complex and make deals harder to negotiate) and buyers might be aggressive about seeking retentions. Locked-box structures have been championed by sellers in recent times but now it is likely buyers will be more insistent upon completion accounts (or partial arrangements) to delay the valuation date and push back some risk onto sellers. Another way to risk share might be to buy a partial stake, instead of a 100% interest, or to provide secured debt alongside an equity position.
- Pricing sentiment: Valuation expectations are likely to have moved (downwards) and unlike 2008/9, this time the shift seems more likely to be on both sides of the transaction table, with a possibility that disconcerted sellers are keener to exit at lower valuations in order to de-risk themselves after the shock of being a business owner in such turbulent times. In the mid-market there are many family-owned or owner-managed businesses which may be attracted by strategies which allow their owners to de-risk. In a similar vein, distressed businesses might be forced into accelerated processes, likely to involve lower prices. Changes to the capital gains tax regime could also mean loan notes which allow sellers to defer CGT liabilities on earn-outs and other deferred consideration will become more attractive.
- Mind the gap: Where a deal has a gap between exchange and completion (perhaps to allow a regulatory clearance or approval to be obtained) there will be more scrutiny than ever of ‘material adverse change’ and similar clauses. It pays to front up to some of these discussions at an early stage, to avoid later misunderstandings and the potential for wasted costs.
- Opportunities: Exchange rate movements and ongoing uncertainty about Brexit, as well as the likely timeframes for the beginning of recovery in different parts of the world, could make deal values in the UK attractive to overseas buyers. There has already been quite a bit of press commentary about the appetite of sovereign wealth funds and other cash rich buyers to make a move for the right kind of UK business. In addition, UK businesses which emerge intact from the crisis could make swift moves to acquire unnerved competitors.
For businesses which can create space to look towards their future strategic goals, this will be a time to keep a watching brief on competitors and markets, speak to advisers about possible targets or exit routes and maintain an open mind about structures and valuation. Whilst the M&A market is certainly subdued, we expect more deals to come on line as opportunistic investors begin to identify opportunities.
Our understanding of the market, even in times which are changing rapidly, means we know how to get deals across the line. There is no legal aspect of an M&A transaction which cannot be completed during the current Covid-19 lock-down. Mills & Reeve has created its own Covid-19 project management toolkit “Executing M&A deals while in lock down”, which ensures the process runs as smoothly as possible during this uncertain time. For more information or to discuss any of the points in this note, please contact James Hunter or any other member of our corporate team.