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Coronavirus - Private equity and the pandemic: Future of M&A Part 1 - Global

  • Global
  • Coronavirus - M and A issues
  • Corporate

12-08-2020

It is arguably difficult to look even to the near future when the world is in the midst of such upheaval and few have been left unaffected in one way or another on a personal level by the havoc wreaked by the Covid-19 pandemic. However, and despite a quieter few months for M&A activity in most sectors, some trends are starting to emerge from the transactions we are seeing and financial sponsors and their portfolio companies should take account of these as markets start to revive, in order to be best placed going forwards if they are looking to engage in M&A activity.

This eighth article in our bitesize series focuses specifically on the some of the areas of M&A where we are seeing or envisage change going forwards, namely: deal origination, deal process including due diligence and the growth of opportunistic M&A. Next week’s article will consider some other areas where we expect to see change in the future of M&A.

Deal Origination

We are already seeing the impact of the strain of Covid-19 on businesses in the form of an increase in businesses teetering on the brink and/or entering into insolvency or administration processes. The financial press is littered with the carnage of big names once considered solid and respectable now brought to their knees and compelled to send out advisers to drum up acquisition interest. The names of the big four accountancy firms are appearing frequently as key players involved in carrying out strategic business reviews before a business faces the chopping block. Whilst corporate finance advisers will no doubt retain a crucial role in origination and advising on M&A processes, the fast-paced environment in which businesses are living on a knife edge means that it will be beneficial for sponsors to maintain a frequent and open dialogue with a broader range of advisers who may have insight into upcoming opportunities and links to possible targets and their management teams.

Investors should be aware that as the investment scene changes, they are likely to encounter a cast of different characters from what they may be used to. The post-financial crisis world has seen a growth in alternative types of investors who may be interested in, and invited to participate in processes relating to, the sorts of distressed opportunities served up by Covid-19 e.g. distressed debt funds, turnaround funds, sovereign wealth investors and family offices, as opposed to only competitor private equity funds. These types of investors may have different tactics or motivations that come into play during a competitive process.

Deal Process

In terms of process, this more fraught acquisition environment will no doubt have an impact upon transaction timetables, with buyers under pressure to demonstrate their ability to complete on an accelerated basis, particularly where they are competing in an auction for a distressed asset. This will have a knock-on effect on various aspects of the M&A process, in particular due diligence (considered in more detail below) and execution.

In circumstances where there is a stable asset which is the subject of a bilateral sale or a process in which a preferred bidder has been identified, it is very possible that the implications arising from the pandemic will have the converse effect, resulting in lengthier timetables where additional time is required to (i) investigate new due diligence issues (on which, see below), (ii) negotiate acquisition documentation where sponsors are seeking to apportion as much risk as possible to the seller, (iii) agree financing terms and (iv) develop a rapport with the other parties due to the logistical difficulties of ‘getting everyone in a room’.

The most obvious and immediate impact of Covid-19 on process however, is a logistical one. Not only are physical meetings off the cards, but with sponsors, management teams and advisers all compelled to work remotely by the global lockdown, parties will need to adapt to negotiating documentation via zoom or tele-conference and executing paperwork via electronic signing software. Whilst these purely practical issues can be managed and solved for, one may be sceptical as to how comfortable financial sponsors will be to execute a transaction alongside a management team without having 'looked them in the eye’ as it were.

That said, potential winners of lockdown include video conference providers with the majority of organisations significantly increasing their usage in 2020. To date, a dominant platform has yet to emerge (think VHS v Betamax) but the ultimate winner is likely to influence deal doing for the next decade. Certain functionality may become mainstream, for example simultaneous language translation, and video conferencing etiquette will also continue to evolve, such as the use of avatars.

Due Diligence

Covid-19 has given rise to a unique set of issues for business, many of which have not previously been encountered, or at least not on the same scale as currently. This will no doubt give rise to a new set of diligence focus areas that vendors will need to be prepared to address during sale processes and buyers should seek answers to as part of their investigations. Similarly reporting formats will need to adapt to accommodate remote access usability requirements. Likely areas of focus include the following:

  • Financing arrangements, including whether there have been covenant waivers or extensions, whether government funding schemes have been accessed, whether preferred shareholder funding has been contributed and, in each case, what the effect of a change of control on these matters might be;
  • Business contingency and continuation planning including reliability of supply chains and insurance coverage. The current situation is not one that will have been foreseen by many and has taken businesses by surprise. Purchasers will be keen to understand how lessons have been learned and how these have impacted future planning;
  • Employment matters in connection with furloughing and government support schemes and details of any completed or intended redundancy processes. Vendors should also be prepared to answer questions about any changes that have been made to employee remuneration and reward schemes and any consequential impact on pension arrangements, and purchasers will need to reassure themselves in relation to the action that has been taken in respect of these matters;
  • Cybersecurity, data privacy and IT resilience are all likely to be a focus given the shift to remote working and the increased reliance on technology to facilitate home working;
  • Real estate arrangements, especially where a target business may have multiple outlets or retail locations. Purchasers will be interested to know whether any rent breaks have been taken and whether any forbearance has been agreed with landlords in relation to tenant obligations. From a forward-planning perspective, purchasers will want to understand the target’s obligations in relation to the term and area of leased property to determine whether there is scope to reduce this as part of a move to flexible working; and
  • Health and safety are likely to be areas of increased focus going forwards as social distancing amongst workforces and with clients and customers becomes the norm and regular sanitisation of workplaces is expected. No doubt employees will also be concerned to ensure that they have personal protective equipment appropriate for their roles and businesses will need to ensure they can provide the right kit in a cost-effective manner.

In addition, a consequence of more remote working and the need for mobile access to due diligence reports is that the nature of reporting must evolve to be more user friendly. The majority of current reports are still designed to be read as a hard copy document and seldom uses the functions available in a purely electronic format. For example, reports could allow the reader to undertake a real time review of data room documents using key terms.

Opportunistic M&A

Aside from changes to how deals are sourced and executed, as described above, the future of M&A may see a shift in the drivers for doing deals, specifically with an increase in opportunistic M&A as opposed to perhaps those transactions where the rationale may be said to be solely strategic. Of course, opportunistic M&A is not a new phenomenon and there are certain types of investor whose investment thesis focuses on opportunistic acquisitions, such as so-called vulture funds, but given the current climate and the increasing number of distressed targets coming under the hammer, the level of opportunistic activity is likely to rise, particularly in sectors such as retail, travel and casual dining.

Financial sponsors in particular are in a strong position to take advantage of these opportunities. Sponsors have record amounts of dry powder waiting to be deployed, whether by way of new investments or bolt on acquisitions to existing portfolio companies. This ready availability of significant financial resource, coupled with a likely downward pressure on prices and the increasingly cautious approach being taken by leveraged finance providers, places financial sponsors in a unique and privileged position.

The fact remains that these are unprecedented times and, although there have been many casualties with no doubt more to come, there are many businesses caught up in this crisis that, at their core, are fundamentally good businesses that have found themselves, for wont of a better phrase, in the wrong place at the wrong time. These businesses are ones that might, pandemic aside, have been successful but have suffered as a result of the extreme circumstances we find ourselves in. These are the businesses that might be considered eligible targets for the bold and the brave of the financial sponsor world to look to acquire now, while the tides are rough, and to take the helm during the storm with a view to reaching calmer waters in the not too distant future.

Provided sponsors are mindful of the likely changes to the way in which transactions are managed and executed, it is arguable that they may find themselves uniquely placed to play a key role in reinvigorating the M&A market post Covid-19.

If you have questions about trends in M&A or this article, please contact the Eversheds Sutherland lawyer with whom you usually work, or any member of our UK Private Equity team.

Next week, as part of our on-going series, Chris Archer will consider the future of M&A in relation to valuation and pricing mechanisms.

Additional contributions from Paul Pugh – Chair of Eversheds Sutherland Future of M&A Group.