Delivering Strategic Corporate Transactions in Surreal Times Delivering Strategic Corporate Transactions in Surreal Times

M&A in surreal times

Against the backdrop of a post-lockdown world we have put together a series of guides to help businesses identify what to consider when approaching transactional activity in the coming months. Click through the below topics to view our brief step by step guides to help you prepare.

Delivering Strategic Transactions In Surreal Times

Bank rescues in surreal times

Strategic contracting in surreal times

Public M&A in surreal times

Tax considerations for M&A in surreal times

Corporate financing in surreal times

What's it worth in surreal times

Accelerating M&A in surreal times

Click here to download all guides in one convenient pdf.

Transacting in the current environment is not for the faint hearted but there are clearly opportunities out there. If you are considering M&A in this surreal, topsy-turvy landscape, here are 8 key issues to bear in mind.

M&A in surreal times: 8 things to consider

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WHAT’S IT WORTH?

PRICING PERILS

THE DEVIL IS IN THE DILIGENCE

CONDITIONALITY: MERGER CONTROL

MAC: A FALSE DAWN?

REPUTATION

INSURANCE AGAINST UNCERTAINTY?

ESG: GREEN IS GO

WHAT’S IT WORTH?

PRICING PERILS

THE DEVIL IS IN THE DILIGENCE

CONDITIONALITY: MERGER CONTROL

MAC: A FALSE DAWN?

REPUTATION

INSURANCE AGAINST UNCERTAINTY?

ESG: GREEN IS GO

Chris Taylor, Corporate Partner, christopher.taylor@addleshawgoddard.com

WHAT’S IT WORTH?

Be wary of past performance when valuing assets – it’s all about understanding a target’s ‘new normal’. Up-to-the minute financial information combined with sector insight is essential. Expect a greater emphasis on management discussions to reveal short- and long-term expectations.

PRICING PERILS

As purchasers want greater control over what they pay, when they pay and performance metrics, we’ll see increasing use of completion accounts, deferred consideration structures and earn outs. But purchasers beware: earn outs can increase the likelihood of disputes and result in unwanted seller controls.

THE DEVIL IS IN THE DILIGENCE

Purchasers may feel the need to ‘double down’ on diligence to fully understand risk. Sellers should expect this and be ready to allay purchaser fears on pandemic-related issues (e.g. fraudulent furlough arrangements). However, purchasers that take an agile, risk-based approach to pursue opportunities will be most successful.

CONDITIONALITY: MERGER CONTROL

Competition regulators look set to continue an interventionist approach to M&A. The ‘failing firm’ exception is likely to be interpreted narrowly. Expect to see increased focus on Foreign Direct Investment controls for foreign purchasers, difficulty in market-testing mergers leading to extended clearance timetables.

MAC: A FALSE DAWN?

Inevitably, purchasers may look for greater ‘walk away’ rights in conditional SPAs, with fraught negotiations likely around MAC rights. If a MAC concept is accepted, we would still expect it to be narrowly defined without reference to wider market triggers. Relative bargaining positions aside, we don’t expect “market” MACs to become the norm in the UK any time soon.

REPUTATION

Right now, any large-scale M&A will be newsworthy. Anticipating and controlling investor reaction to transactional activity is critical. We may even see sellers proposing antiembarrassment clauses in their SPAs to protect against the reputational fall out of under-cooked valuations.

INSURANCE AGAINST UNCERTAINTY?

With purchasers looking for extended warranty cover to mitigate risk, whilst limiting vendor protections, negotiation friction is inevitable. Insurers are responding by dropping premiums, pre-defining templated W&I coverage and introducing new products (like synthetic tax covenants), but remember – insurers will only cover risks provided there is reasonable purchaser diligence. W&I is not a panacea solution.

ESG: GREEN IS GO

We still expect ESG considerations to be at the forefront of minds when considering M&A. Being able to measure, track and report performance against ESG metrics will be vital for purchasers who will build this into their transaction delivery models.

Bank rescues in surreal times: 7 things to consider

As banks continue to feel the financial and operational strain from these surreal times, here are 7 key areas for any bank considering a rescue of a failing UK bank, by way of a partial transfer.

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PREPARATION IS KEY

CLARITY ON SCOPE OF BUSINESS

SECTION 75 ORDERS

VALUE ADJUSTMENTS

SWAPS

EMPLOYEE AND PENSION LIABILITIES

COMPETITION AND STATE AID

Hugh Lauritsen, Corporate Partner: Hugh.Lauritsen@addleshawgoddard.com

PREPARATION IS KEY

Any rescue transaction requires swift and efficient engagement as time is limited. Having a playbook prepared to ensure that a rescuing bank is able to engage the necessary internal and external team to deliver the transaction will maximise its competitive position in any auction process and help it more effectively mitigate the transaction’s associated risks. Preparation is key.

CLARITY ON SCOPE OF BUSINESS

The Banking Act and the transfer instrument itself will accommodate an effective split of the in-scope business of the failing bank and its transfer to a rescuing bank. Having a clear internal view of what classes of assets and related liabilities you intend to acquire and exclude will help formulate an offer for the relevant parts of the failing bank and accurately describe the business that is inscopefor transfer.

SECTION 75 ORDERS

HM Treasury may exercise its power under section 75 of the Act to modify legislation and common law to facilitate a resolution. This is an effective tool but is likely to be used sparingly. Having a clear picture of the business a rescuing bank would be prepared to acquire will allow the bank to focus on whether any modification under section 75 would be required to achieve the split from the failing firm.

VALUE ADJUSTMENTS

In the absence of an SPA or BPA, there may be difficulty in testing the price paid for the transferring business. A post-acquisition adjustment would ordinarily be sought but which party would make any required payment to the rescuing bank (the failing firm or HM Treasury)?

SWAPS

Engage early with your Treasury team to ensure that the application of the Partial Property Safeguards Order to related swaps, engagement with your new swap counterpartiesand implementation of a swaps close out procedure post acquisition, can each be dealt with smoothly int he immediate aftermath of an acquisition.

EMPLOYEE AND PENSION LIABILITIES

Treatment of the failing bank’s staff and any associated pension liabilities is likely to be a key concern for the tripartite authorities. This will include whether the entire body of staff will transfer to the rescuing bank or just those assigned to the transferring business. This will impact how the transferring business and any business placed with a bridge bank or into administration will be serviced following the split.

COMPETITION AND STATE AID

Whether a transaction takesplace before the end of the Brexit transition period or under the new UK State aid regime, it may involve state aid and require analysis to determine whether there has been any distortion to competition. Will merger control rules apply to the acquisition and will support be required from the tripartite authorities in any failing firm argument? Can the Secretary of State intervene on public interest grounds if the transaction is necessary to ensure the stability of the UK financial system?

Strategic contracting in surreal times: 8 things to consider

Whilst corporate appetite for commercial transactions remains undiminished, the rules of engagement have changed in the current, surreal landscape. Here are 8 key areas to consider with your contract arrangements in the months ahead:

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TESTING SUPPLY CHAIN RESILIENCE

CONSIDER THE STRATEGIC IMPACT

TRANSITIONARY CHANGES

STRATEGIC REVIEWS OF CONTRACTS

OPERATIONAL RESILIENCE

FACILITIES MANAGEMENT

THE CONTINUOUS RISE OF INNOVATION

ACCELERATED DISRUPTION

Fiona Ghosh, Commercial Partner Fiona.Ghosh@addleshawgoddard.com

TESTING SUPPLY CHAIN RESILIENCE

Many of the traditional concepts of third party management were turned on their heads due to the explosive impact of the unplanned global lockdown. Large institutions, who traditionally held procurement power, saw that risks of continuity of supply were more important than standard terms. Sustainability of supply chain, testing resilience and flexibility are now key features of any negotiation, especially in consumer-facing businesses such as retail, food, transport and retail banking.

CONSIDER THE STRATEGIC IMPACT

Whilst contracts do usually include practical methods for dealing with a crisis (force majeure and frustration), recent events have shown that they are not a panacea. Look beyond just the technical aspects of agreements and consider the strategic impact of contracts, the impact of risk and the considerations for the future relationship.

TRANSITIONARY CHANGES

COVID-19 is a stark reminder that contracts never exist in a vacuum. We are seeing companies continue to focus on ensuring business continuity, continued rapid increase in technology adoption, and reactionary changes to both supplier and customer bases. We expect short term contract fixes to continue for the coming months before longer-term views are able to be accurately assessed.

STRATEGIC REVIEWS OF CONTRACTS

We expect to see many institutions undertaking strategic reviews of their contract estates in the coming months. There will be a greater focus on resilience, contract flexibility, greater use of cloud, mobile functionality, as well as contract provisions reflecting changing work patterns and property needs post-COVID. Many parties will not have much exposure to some or all of these topics, and so expect new points to arise technically and in negotiation.

OPERATIONAL RESILIENCE

Financial Services companies are already well aware of the increasing regulatory requirement for operational resilience. This will be much more than just a procedural exercise going forward, with regulators have already indicated how critical this area has now become. Importantly, expect to see resilience become a key feature in many other sectors. For example, we are already advising multiple corporate clients to adopt similar focus to their FS counterparts for the sake of good business practice.

FACILITIES MANAGEMENT

REPUTATION

One area which may come under pressure is facilities management, particularly as the commercial property market softens and working patterns change. Flexibility, technology and employment issues are among those that are likely to heighten in importance and frequency as companies seek to renegotiate the next generation FM deals in a post COVID environment.

THE CONTINUOUS RISE OF INNOVATION

With the continued importance of innovation to respond to evolving client demands and competitive pressures, contracts are becoming more flexible, reactive and in some cases, creative. This will present many opportunities, particularly for companies such as FinTechs. While we expect liquidity to remain under pressure for many companies for some time yet, this is the perfect time to consider protection of Intellectual Property of new thoughts, concepts and software solutions to meet fluid business needs.

ACCELERATED DISRUPTION

Without a doubt, the near future will produce accelerated disruption and opportunities for those companies who are insightful & equipped with the right management and advisors. In particular, we see sectors such as transport, financial services, retail and automotive under most threat from continued cost, regulation and technology challenges– but opportunities will also present themselves. Strategic consideration of joint ventures, partnerships and strategic alliances, both within the UK and internationally, will inevitably increase.

Public M&A in surreal times: 8 things to consider

The operation of stock exchanges has been disrupted by Covid-19, and market participants are working through the changes. If you couldbe party to a public takeover in this unusual deal landscape, here are 8 key themes to note.

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VALUATIONS ARE THE BIGGEST HURDLE

PRIVATE EQUITY INTEREST IN P2PS TO ACCELERATE IN H2

“CHEAP STERLING” WON’T BE A KEY DRIVER OF PE ACTIVITY

ACQUISITION FUNDING NEEDS TO OPEN UP

DISTRESSED AUCTIONS ON THE RISE

CHANGING M&A MARKET PRACTICES

BREXIT IMPACT ON DEAL CONDITIONALITY

FOREIGN DIRECT INVESTMENT

Simon Wood, Partner, Corporate Finance simon.wood@addleshawgoddard.com

VALUATIONS ARE THE BIGGEST HURDLE

Covid-19’s interruption of long-term cashflows complicates valuations for many businesses – although interim results season in August will provide clarity on H1 Covid affected trading. This uncertainty, plus the expectation gap caused by PLCs recen thigher share prices means target boardr ecommendations may be harder to obtain.

PRIVATE EQUITY INTEREST IN P2PS TO ACCELERATE IN H2

PRIVATE EQUITY INTEREST IN P2PS TO ACCEL

AG’s survey of PE houses identified three interlinked factors behind “public-to-private” activity: (1) scarcity of quality businesses for sale, (2) increased competition among PE houses, and (3) PLCs providing better value proposition. Covid-19 exacerbated these factors, and PE interest will remain a systemic feature of the deal landscape.

“CHEAP STERLING” WON’T BE A KEY DRIVER OF PE ACTIVITY

One common 2019 narrative was ‘cheap sterling’ will cause a US-led deal frenzy. Our survey showed 80% of financial advisers and 55% of PE houses named the UK as the source of P2P interest. The key commercial drivers above will dominate and favourable exchange rates will remain a relevant, but subsidiary, factor.

ACQUISITION FUNDING NEEDS TO OPEN UP

Lenders have focussed on their existing customers and loans: for M&A to be unlocked, the scope of lending must widen and commercial terms will shift in lenders’ favour to reflect valuation uncertainties. Given their unutilised cash reserves, debt funds are likely to pick up the lending baton first.

DISTRESSED AUCTIONS ON THE RISE

There has been minimal takeover activity during lockdown - but several distressed PLCs have entered offer periods having put themselve sup for sale through a formal auction process, as part of a multi-limbed strategy while they also consider alternative strategic and funding options.

CHANGING M&A MARKET PRACTICES

AG is working on innovative solutions to combat some of the headwinds offer participants face in the current deal environment – bespoke solutions, like contingent value rights and insurance, will receive more regulatory scrutiny. Expert guidance through the Code’s regulations will be critical.

BREXIT IMPACT ON DEAL CONDITIONALITY

Away from Covid-19, the Code’s conditions regime must be amended to address the anomaly, which is particularly evident in a post-Brexit world, that EU antitrust conditions receive special treatment under the Code when invoked compared to those in other jurisdictions. This playing field will be levelled.

FOREIGN DIRECT INVESTMENT

The new FDI regime introduces a new complexity into the deal clearance process, with the possibility of parallel reviews with the CMA and inconsistent timetables and outcomes as a consequence. More transactions will requirere gulatory approval and uncertainties around deliverability will increase.

Tax considerations for M&A in surreal times: 8 things to consider

It is easy to lose sight of tax considerations in the middle of a corporate acquisition, but you can minimise surprises with forward thinking and a clear view of what the key issues might be. Here are 8 points to keep in mind.

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TAX PITFALLS WITH EARN-OUTS

AVOID UPFRONT TAX LOSSES PAYMENTS

TAX AND W&I INSURANCE

DEBT RESTRUCTURING PRE-SALE

KNOW YOUR RISK APPETITE

EQUITY INCENTIVES

CHERRY-PICKING ASSETS

DON’T FORGET TAX LIABILITIES MAY HAVE BEEN DEFERRED

Paul Concannon Partner, Tax & Structuring paul.concannon@addleshawgoddard.com

TAX PITFALLS WITH EARN-OUTS

Earn-outs can be a good way to bridge price expectation gaps, especially if founders are selling, but can cause material tax charges if treated as employment income. Red flags include only employees benefitting from the earn-out and dependency of the earn-out on personal performance.

AVOID UPFRONT TAX LOSSES PAYMENTS

Many targets will have tax losses that in theory could be valuable in future, and sellers may want to monetise those immediately. However, there are many restrictions on the use of tax losses after a sale and buyers should avoid paying for losses upfront or assuming these will be available when pricing.

TAX AND W&I INSURANCE

W&I insurance can be helpful, but policies typically limit tax coverage. Most insurers exclude some tax risks entirely, e.g. transfer pricing, as well as excluding known risks. This means insurance provides less cover than a typical tax covenant. Extra cover may be available, but at higher cost.

DEBT RESTRUCTURING PRE-SALE

Pre-sale restructuring of distressed targets is common, but it is critical to look at thedetail to ensure no tax charges arise. Even on a relatively simple debt for equity swap there are numerous hurdles to a tax-neutral result – tax charge scan leak considerable value.

KNOW YOUR RISK APPETITE

Lots of targets won’t necessarily be “clean” in tax terms. If anacquisition is competitive it is important to know in advance your appetite for tax risk, what cover you will realistically get from sellers/insurers, who needs to approve taking on a risk and how fast your internal processes can move.

EQUITY INCENTIVES

Depressed equity valuations offer an opportunity to set up incentive plans without triggering tax charges, but take care not to set performance hurdles too low. Low hurdles combined with a swift recovery could lead to equity vesting unexpectedlyr apidly – and call into question the original tax valuations.

CHERRY-PICKING ASSETS

Buyers might only want part of a business. When splitting up a corporate group it is important to bear in mind the tax degrouping charges that canarise, the tax treatment of any reorganisation that is needed pre-sale, and secondary liability exposure to unpaid taxes of entities not acquired.

DON’T FORGET TAX LIABILITIES MAY HAVE BEEN DEFERRED

As part of its Covid-19 response the government allowed businesses to defer tax liabilities, under general schemes and bespoke “time-to-pay” arrangements. If your target has deferred a tax bill clearly it is important to know exactly what has been deferred, when it is due and how the cost will be funded.

Accelerating M&A in surreal times: 7 things to consider

The ongoing pandemic will cause upheaval across all markets and sectors. Business models may become unviable. Sound businesses will suffer short-term liquidity crises. Customer behaviour may alter. Distress opportunities can create opportunity if buyers can work to an accelerated timeline.

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IT’S NOT JUST INSOLVENCY

DEAL STRUCTURES MAY VARY

DISTRESSED BUSINESSES DO NOT HAVE THE LUXURY OF TIME

MANAGE THE RISK

IS W&I THE ANSWER?

HAVE YOUR CHEQUEBOOK READY

IT’S TOO LATE WHEN YOU READ IT IN THE PRESS

Graham Cross, Partner, Tax & Structuring graham.cross@addleshawgoddard.com

IT’S NOT JUST INSOLVENCY

Distressed acquisitions come in many forms. Various outcomes can be progressed before the administrators are called in. Increasingly business owners and creditors will look at a range of options including accelerated M&A, non-core divestitures, or capital injections, to avoid formal insolvency, help viable businesses continue as going concerns and maximise value.

DEAL STRUCTURES MAY VARY

Buyers should be flexible as the transaction could be either a share or asset deal. The key to success for a buyer will be the ability to transact quickly, offer a deliverable outcome for the sellers and creditors whilst managing internal risk.

DISTRESSED BUSINESSES DO NOT HAVE THE LUXURY OF TIME

Buyers must be able to identify and understand key issues, evaluate strategic fit and manage downside risk quickly and efficiently. There is no single solution for this, but an efficient and focussed diligence exercise, streamlined internal processes, experienced advisors and flexibility will all help.

MANAGE THE RISK

Risk in mainstream M&A is mitigated through extensive diligence and warranties. But these are commonly unavailable in distressed acquisitions. Deals happen quickly and warranties (if given at all) may not have much value once creditors have been paid. A successful buyer may need to employ different strategies, such as alternative pricing structures, management incentives or insurance to help manage deal risks.

IS W&I THE ANSWER?

Synthetic W&I products provide a set of warranties that an insurer will pay out against without a seller having to give contractual warranties. Buyers will need to assess the time and cost of putting the policy in place and the need for a reasonable level of diligence to be provided to the insurer so it can evaluate the risks.

HAVE YOUR CHEQUEBOOK READY

Cash is king for sellers who often require the price to be paid in full on completion. Although deliverability and speed of execution will also be assessed (so price isn’t everything). Buyers should have funding lined up. A buyer who is relying on new bank facilities to do the deal may lose out to those with cash on their balance sheet or unconditional funding inplace already.

IT’S TOO LATE WHEN YOU READ IT IN THE PRESS

Distressed businesses come to market quickly and deals complete even faster. Awareness of opportunities is therefore key. This could be relationships with businesses you are tracking or speaking with the corporate finance houses and insolvency practitioners who commonly advise distressed businesses so you are front of mind.

Corporate financing in surreal times: 6 things to consider

With the public health and economic position continually evolving, businesses will be considering how to finance their recovery and future growth strategies for the months ahead. Against this backdrop, we have identified 6 key issues for businesses to consider in this changing environment.

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FINANCIAL COVENANTS

PROJECTIONS AND FORECASTING

LIQUIDITY

WAIVERS AND CONSENTS

CREDIT PROCESSES

ESG

Catriona Smith, Partner, Finance catriona.smith@addleshawgoddard.com

FINANCIAL COVENANTS

Many sets of financial covenants have been temporarily amended in order to track true business performance during the pandemic. Given the impact on revenues, use of liquidity rather than EBITDA-based covenants has been prevalent, though variations on ‘EBITDAC’ (i.e. ‘adding back’ pandemic losses) have also been used. We expect future financings to include tests that seek to ensure both performance and liquidity can be tracked.

PROJECTIONS AND FORECASTING

As accurate forecasting becomes more difficult, we expect to see a greater focus on discussions with management teams to inform a business’s performance, alongside a range of sensitivities. Careful preparation and interrogation of financial information and forecastsi s vital. Funders may take significant comfort from the views of a trusted management team alongside the financials themselves.

LIQUIDITY

With a weakened economy and increase in failing businesses, areas of the market might see constraints on liquidity. That said, there remains significant lending capacity within banks and other lenders, as well as political and economic drivers to support business. As well as seeking headroom to weather uncertainties, some borrowers may seek additional capacity to take advantage of strategic growth opportunities.

WAIVERS AND CONSENTS

Proactively consider documentation to address future waivers / consents, whether due to unsteady financial performance, future government restrictions, suspension of business, pandemic carve outs and impact on set timeframes for delivery of items /completion of events. Seeking to anticipate what lender / equity requests might look like alongside projections and demonstrating a collaborative approach will gain support.

CREDIT PROCESSES

Be mindful that the inherent uncertainty resulting from the pandemic is likely to lead lenders to require enhanced credit processes so that they fully understand the businesses and impact of what might be the ‘new normal’ as it applies to the particular sector and circumstances.

ESG

We expect sustainable finance and ESG considerations to re-emerge as a key consideration. As businesses jostle for their place in their own sector and seek capital in a more constrained lending market, green and sustainable financing options will contribute towards making a more supportable proposition.

What’s it worth in surreal times: 8 things to consider

Conventional valuation methodologies and tools are all challenged by this year’s turbulence, with business performance in targets both way below and indeed way above usual expectations. There is a clear challenge in understanding what is ‘normal’, what is an appropriate basis for pricing a deal.

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PINNING IT DOWN

SIGNED…

…BUT NOT CLOSED

CLOSURE

BUSINESS TRANSITION

POST-CLOSING VALIDATION

LATENT VALUE

JAM TOMORROW

Andrew Rosling, Corporate Partner, Andrew.Rosling@addleshawgoddard.com

PINNING IT DOWN

The usual financial and commercial debate between sellers and buyers and advisers, on steroids, with extreme variances in expectations and positioning. These may be commercially resolved, they might need the structures below to bridge the gap. Or indeed an innovative approach to secure a competitive edge in a bid process. We are also seeing reverse premia being actively considered more often by sellers determined to cut losses and focus on core strategic areas.

SIGNED…

Deal signed, price settled! Or is it?

…BUT NOT CLOSED

Gap periods might usually allow walkaway rights but if you need a gap might it also be used to adjust price, if specific events, upturns, milestones are reached during the period? Might the ‘go shop’ option (last seen in the financial crisis over a decade ago) turn up again? Seller contracts to sellto A at £x, but has a window to find B or C and sell for £x+, compensating A if it succeeds.

CLOSURE

Sellers are still seeking to impose locked boxes but it is usually hard to see the rationale given the likely volatility since the likely accounts date and a new world of ‘leakage’. Completion accounts are also challenging but may be enabling: how do you set ‘normal’, what do you test? are there specific additional balance sheet items or performance metrics at completion that can also benefit from the ‘audit’ process and retest pricing assumptions?

BUSINESS TRANSITION

There is a greater focus at the moment on ensuring a successful business transition (has it lost customers or licences or contracts through the transition?) – what is the price change formula?

POST-CLOSING VALIDATION

Deferred consideration is really popular – additional payments made on hitting specific benchmarks, eg return to pre-covid revenue/margin, or customer orders, or room occupancy levels. This also evolves into earnouts, with the usual and some extra covid-specific debate around how the target business is run and integrated. Deferred structures can also be a neat way of dealing with buyer set off rights (eg a warranty or indemnity claim). Talking of which we think we will also see more warranty claims…..And maybe anti-embarassment mechanisms where sellers have had to settle for a price below expectations.

LATENT VALUE

Remarkably, especially in a public M&A context, the price GVC paid for Ladbrokes was adjusted by a specific formula tied to a post-closing government policy (maximum FOBT bet size) – can similar external factors be used to bridge value expectations, eg tied to how long specific sectors benefit from business rate or VAT relief?

JAM TOMORROW

Sellers and management might want to retain some equity to capitalise on underlying value that they see as only temporarily damaged – should corporates be thinking more like PEbuyers and letting sellers keep more skin in the game?

Download all guides

download all guides

M&A in surreal times

Bank rescues in surreal times

Strategic contracting in surreal times

Public M&A in surreal times

Tax considerations for M&A in surreal times

Corporate financing in surreal times

Accelerating M&A in surreal times

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Legal Notices.

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What's it worth in surreal times