Investors and advisers have been poised for a flood of distressed M&A transactions since the early days of the pandemic. To date, deal flow has been more of a trickle but with companies now firefighting a perfect storm of economic (inflation, interest rates) and logistical (supply chain, labour) issues in a generally volatile geopolitical context, 2023 is likely to see that trickle become a flood.
Whilst each business under pressure will have its own set of challenges, there are certain considerations common to almost all distressed M&A transactions – the most important being that they are often run on a limited timeframe, on the basis of limited information and with limited contractual protections. This article provides a short introduction to some of these considerations and more detail can be found at here.
On your marks… Because a seller will want to conduct an accelerated process, a buyer who is able to move swiftly, on an unconditional basis, will be more attractive than a buyer who cannot. This means ensuring that financing is lined up, deal teams are well briefed and identifying (and then limiting) any regulatory or third party processes to ‘must haves’ rather than ‘nice to haves’. Another key area of pre-deal preparation is identifying where the target sits on the distress spectrum as this will impact timetable, who a buyer is dealing with (directors or an insolvency practitioner) and the sale process if the target is actually in formal insolvency proceedings.
Share or asset sale? If a buyer is concerned about what is in the Pandora’s box being bought it is likely to prefer structuring the deal as an asset sale so it can ‘cherry pick’ the attractive assets and leave behind, to the extent legally permissible, the liabilities. An added advantage of this approach is that the buyer can focus diligence on an identified pool of assets (and their ability to be sold freely and cleanly). However, it is critical that the tax and accounting implications are considered as early as possible. Depending on the level of distress, a buyer may also feel safer biding its time until the target enters a formal insolvency process and then contracting with the administrator as it removes the risk of a deal being challenged as having been implemented at an undervalue.
Due diligence Diligence is unlikely to be conducted at the buyer’s leisure and there is unlikely to be a full suite of material available. Nor may buyers have access to accurate financial information or key employees. Buyers need to identify which areas are material to them and whether these have a purely financial consequence capable of being factored into the valuation or are of wider concern - for example environmental liabilities or bribery concerns.
Risk allocation (W&I) In ‘normal’ M&A deals, diligence informs the scope of the warranties and indemnities to be included in the purchase agreement. In a distressed deal, however, the seller is likely to be unwilling or unable to provide contractual comfort and this is a particularly acute issue when buying from an administrator. It may be possible to mitigate some of these risks via W&I insurance and the possibility of putting in place a more expensive ‘synthetic’ policy – where a warranty package is directly negotiated with the insurer - is particularly helpful when dealing with administrators. However, this may impact timetable and coverage is likely to be heavily caveated unless discussions with brokers are initiated early in the process so as to reflect the insurer’s demands on diligence scope.
Risk allocation (pricing) There is an inevitable tension between the seller who wants certainty of consideration (both as to quantum and timing) and the buyer who is wary that they haven’t been able to accurately assess the target’s financial position. For example, a buyer will be wary of utilising a locked box structure based on financials which are unlikely to reflect recent stresses experienced by the target whereas a seller won’t want the delay of preparing completion accounts and the risk of the headline price being materially eroded. And similar arguments will arise when trying to bridge a valuation gap - or providing recourse against future claims – by way of deferred or contingent consideration.
It’s not over until the creditors (don’t) sing... all parties should be aware that the deal is not safe simply because it’s completed. If it transpires that the transaction was effected at an undervalue then there is a risk of ‘clawback’, in other words the deal being challenged and unwound. This risk may be more or less acute depending on the jurisdictions involved. This is one of several reasons why it is critical that directors of a distressed target and its owners get appropriate professional advice as to their duties and valuation, particularly as they risk incurring personal liability if they get it wrong.
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Key legal and regulatory developments driving and shaping M&A
The buyer’s perspective
Bridging the valuation gap in times of uncertainty
Rising interest rates, long-lasting inflation, supply chain uncertainty, regulatory changes, pressure for business transformation, geopolitical instability, economists predicting a global recession – dealmakers are increasingly confronted with extremely challenging conditions that affect their M&A-roadmaps.
M&A trends in Asia: The outlook for 2023
Asia has not been immune from the global macroeconomic headwinds that have built steadily over the course of 2022, and is now also experiencing rising inflation and interest rates and tightening monetary policy, albeit perhaps not to the level seen in the West.
Tech M&A: A return to pre-pandemic levels?
Following a surge in M&A activity in 2021 and the first quarter of 2022, deal making in the Tech sector slowed significantly through the remainder of 2022.
The outlook for banking sector M&A in 2023
There continues to be longstanding speculation in the market about when a next big round of consolidation in the banking sector might occur.
ESG in Canadian M&A and Shareholder Activism: Perspectives for 2023
Despite somewhat shaky economic conditions and geopolitical upheaval on the world stage, M&A activity in Canada was relatively steady in 2022.
European Private Equity: A broadly positive outlook despite economic headwinds
After a record-breaking year in 2021, 2022 demonstrated that the years of predictable growth in the private equity industry have, at least temporarily, come to an end.
M&A in the Middle East builds on active 2022
Proving its resilience and ability to weather political headwinds, the Middle East region saw a particularly active year for M&A during 2022, with several deal-makers citing pre-pandemic levels of activity.
Merger control in Europe: Will the increased scrutiny of deals impact M&A in the year ahead?
2022 saw the rhetoric about “killer acquisitions” made concrete. Both the European Commission (EC) and German Federal Cartel Office (FCO) fought to defend their ability to review acquisitions of entities with limited EU presence, revenue and customers, with the EC’s jurisdiction confirmed by the EU’s General Court (GC), and the FCO losing at first instance.