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The Impact of Pandemic on Mergers And Acquisitions

The unprecedented pandemic that hit the mankind with great gravity as witnessed after a century, the world had not anticipated a situation where across the globe personal and commercial agendas would be brought to a standstill. It felt as though this phase is going to shape a new era! An era where terms like quarantine, lock-down, social distancing, etc were set to replace the previous way of life and become the so called New-Normal. Pandemic has caused business interruptions and every business whether big or small have been adversely impacted causing furloughs, pay cuts and stalling of corporate actions and deals globally.

M And A world has been through economic crises and financial instabilities, however, this time the M And A deals are not only affected by financial parameters but a plethora of factors associated with the on-going pandemic situation. It has been announced that SoftBank Group Corp terminated tender offer for up to $3 billion worth of share of WeWork. SoftBank stated that the termination was due to unfulfilled closing conditions that included government actions pursuant to Covid-19 which imposed restrictions against WeWork and its operations. While on the other hand India's Reliance Group company, Reliance Jio has backed and converted huge investments from Vista, Facebook, silver lake during these uncertain times.

While we are trying to adapt and outgrow what nature has thrown our way, there are tremendous changes in the perspective with which corporate actions like Mergers And Acquisitions are being navigated in this scenario. Corporates and financial intermediaries are carving out new approaches which are possibly going to re-shape the procedures and technicalities involved in concluding M And A deals. These factors could be the basis on which deals are made or broken in this changed environment.

This article attempts to highlight and analyze the components to be taken into consideration while structuring M And A deals amidst the pandemic:

Due-Diligence Issues
Due-diligence is an essential activity for a buyer to confirm pertinent information about the seller like contracts, compliance and finances of the company. Due-diligence activity helps to analyze the risks involved in the legal and financial problems of the target company.

The following would be the crucial areas around which due-diligence today would revolve:
- Considering how important this activity is, the limitations imposed due to travel restrictions and work from home (WFH) pose as a hinderance for smooth inspection without physical visits. Accordingly, seller company needs to design a protected mechanism and system so that all the data required to be scrutinized can be accessed remotely by the authorized persons.
- Revised Financial projections are analyzed by acquirers to emphasize on the degree of change in the projections and how achievable are the new projections in the current market scenario considering the current liquidity and estimated cash flows.
- The acquirer is obliged to fulfill the contractual obligations entered by the target company. Thus, apart from the legality of the contracts entered, the acquirer would focus on whether or not the contracts entered by target company include Force Majeure clauses that may enable it or the counterparty to terminate the contract or performance of the contract.
- Scrutiny of customers portfolio and debtors and risks involved in recovery of receivables.
- The changes in the employment policies including furloughs and pay-cuts if any. Identifying the key employees and management personnel and devising a strategy to have a balanced team with existing employees, so that the company's business decisions are not hampered in case unfortunate pandemic situation faced by any employee.
- The acquirer shall also scrutinize whether the target company qualifies as an MSME and are eligible to take advantage of collateral free loans fully guaranteed by Centre and loan moratoriums. If so, the effect of these terms on the future plans of the target company will be examined.
- Insurance policies that the company is covered under and whether the losses as a consequence of Covid-19 are insured under these policies or any policy exceptions.
- Lastly, the acquirer would also consider the compliance Business Continuity Plan, Crisis Management procedures and health and safety measures in workplace.
  
  These incremental due-diligence could affect the relative bargaining power of the parties involved in the purchase agreement
Availability of finance for acquisitions:
Acquirers generally funds their acquisition partially through debt. However, the current volatility has made it difficult and challenging for lenders to provide financing. As many businesses are facing cash crunches, the risk of loan getting converted into an NPA (Non-Performing Asset) is greater.

Thus, there could be additional security or terms that the lender would want to impose to ensure that the advance does not go bad. The negotiations with lenders and production of additional documents or requirements could be arduous and time consuming. The seller needs to foresee and be prepared for any kind of delay as buyer's liquidity issues could significantly affect the closing of the deal.

However, as attractive as acquisition transactions seem, is it really favorable to finance buyouts with debts. Professor Aswath Damodaran determined that coronavirus pandemic was 'not a full-scale panic where all stocks were punished indiscriminately.'

He noted:
There was actually a rationality of how market knocked down stocks.' Professor Damodaran explained that the best performing industries spanned from medical service sectors to those supplying daily essentials like toilet paper, cleaning supplies and food.

The worst performers included financial services due to the defaulted debts. He noted that most of the poor performers held large amounts of debt adding, 'the cautionary tale coming out of this crisis is companies should be much more careful about pushing the financial leverage button to obtain growth. This is the dark side of debt.'
Impact on Negotiations, Term sheets and Letter of intent:
Pandemic has posed new challenges in conducting of due-diligence activity and this has caused a deviation from the normal course in which negotiations and terms were established. Presently, buyers feel justified in going forward with any kind of negotiations only after completion of incremental ground level due-diligence and contemplating the degree of adverse effects of the pandemic on the buyer's business and related markets. The period involved would vary depending on the seller company's compliance history and financial portfolio.

However, when the negotiations begin between the two parties, the buyer would definitely attempt to include the scope of Material Adverse Effect (MAE) in the closing conditions, stringent pre-closing covenants and drop dead dates. The buyers would also intend to have longer periods of exclusivity in anticipation of any fall outs due to the pandemic considering the volatility in the current market. This is not completely in favor of buyers as the sellers could terminate the period of exclusivity in case of any indication about the transaction having no future.
Agreement terms and specific contractual language:
Definitive purchase agreements are documents used for transfer of ownership of a company that includes terms and conditions such as purchase consideration, asset purchased, indemnity, representation And warranties, closing conditions, dispute resolution, etc. Even in the pandemic scenario, there are strategic investors and buyers whose liquidity has not been severely affected.

These cash-rich investors are looking for strategic alliances with companies having promising product strategy and financial estimates for the near future. However, there could be two approaches here, investors with short term goals that intend to buy companies bearing financial returns in near future or with long term goals wherein the post pandemic situation is considered even though the business might not be profitable in current scenario (viz. hospitality, travel, aviation, co-working spaces, etc). However, the pandemic has placed the buyers/acquirers in a position with greater leverage than the sellers and thus dictating the deal terms to some extent.

The following are the clauses that have been impacted:
- Material Adverse Effect/Change Provisions (MAE/MAC):
  MAE definition sets the parameters for which a buyer is permitted to terminate the transaction if there is a material adverse event affecting the target company. With the onset of the pandemic every party to an agreement would review the terms to determine whether they have a right to terminate or suspend the performance of obligations or re-negotiate the terms of the agreement based on the material adverse change caused due to COVID-19.
  
  The buyers would emphasize on certain contractual language including the disproportionate clause in order to conclude transactions and would specifically exclude pandemic from the carve outs. So while determining the MAE, the buyers would seek to include pandemic situation like COVID-19 or similar health crisis along with disproportionality clause so that the buyer can still take shelter under MEA if the target company has been affected more than its competitors in the market during the pandemic.
- Pre-closing Covenants:
  There could have been breach of certain standard covenants due to the restrictions laid down by the government during the pandemic. The seller can propose the buyer to consider these deviations as exceptions and both the parties would need to deliberate on whether these breaches could have been avoided and to what extent have they deteriorated the interest of the buyer in the business. In new agreements, the seller would want an assurance that reasonable acts done in response to the pandemic such as workforce reduction, increase in expenses to deal with pandemic and keep business running, capital changes, changes in personnel policies and compensation plans would not be considered as breach of covenants. However, the buyer and seller need to have mutual understanding and approvals.
- Indemnity and Representations:
  Representations are given in order to make the other party familiar with the internal state of affairs that cannot be known unless you are an integral part of the business. Buyers would emphasize on providing broader indemnities and representations during the pandemic situation. This would include relationship with customers, notices invoking the force majeure clause and suspension of performance by suppliers/customers, compliance issues, seller's contingency plans and future prospects of the existing or proposed business transactions. Representations are crucial for buyers for making a decision whether to go ahead or walk away from the transaction.
- Drop Dead Dates:
  Drop dead dates is a date after intended closing date post which either party can terminate the agreement due to any kind of unforeseen delays. This could be caused majorly due to non-receipt of regulatory approvals. During the pandemic situation both parties will consider extending the period of time between signing and the drop-dead date as the functioning of regulators viz. Stock Exchanges, SEBI, ROC have been significantly impacted by the pandemic delaying the receipt of approvals.
Price Adjustment provisions:
In M And A valuation, Discounted Cash Flow (DCF), Net asset value (NAV) and Market Price are the broadly used methodologies involved in carrying out valuation of target company. However, it is pertinent to understand the changes in the price adjustments provisions during the pandemic. Professor Aswath Damodaran in his speech delivered to this year's CFA Institute Annual Virtual Conference said 'Go Back to Basics' regarding valuations.

He advised investors to stick with traditional valuation tools with adjustments for the pandemic. The purchase price adjustments in valuation methods based on the target company's cash liquidity and indebtedness as on the close of the financial year could result in reduced net purchase price due to the additional expenses and fluctuating cash flows. From the point of view of working capital, the new levels of scrutiny by the buyers may lead to greater levels of normalized working capital to ensure adequate capital for future operations. These adjustments pursuant to the pandemic could lead the sellers to face loss of credits that they would have otherwise received.

The pandemic has led to increase in distressed M And A transactions where the target company is in dire need of financial assistance or a dynamic management in order to restructure the business and ensure business continuity. While we are striving through this phase, what it has taught us is that uncertainty is the way of life and not all plans might materialize. However, it has also made us realize that no matter what life throws our way, we can always find a way out of it!

Award Winning Article Is Written By: Ms.Disha Shenoy