Transactions in difficult times of corona virus

​​The Covid-19 pandemic dominates our daily lives and thus also has a far-reaching impact on M&A transactions: While the healthcare sector or the IT industry see an increased number of deals, additionally fuelled by the Covid-19 outbreak, the economic situation in other industries has worsened. It's testing time for company financing solutions; approvals from authorities or boards are no longer granted. In addition, the range of temporary aid offered by the federal government to companies is currently very heterogeneous. Against this background, the earnings situation, in particular, and thus the valuation of companies in the context of transactions, is becoming more complex. Generally, the impacts of corona virus on the M&A business are very diverse and, above all, multi-layered.
 
This article gives a brief overview of the impacts of the corona virus pandemic on the earnings situation and the balance sheet, currently being a hot topic in the M&A business as a direct result of the pandemic. In addition, the article aims to provide an insight into risk-mitigating mecha­nisms for the buy-side in an M&A transaction, which are becoming increasingly important in the current market environment.
 

Impact on the earnings situation

In the wake of the corona virus pandemic, many companies struggle to keep their head above water with their sales revenues coming under pressure due to partial or total lockdowns and the related slump in demand. Companies that delay adjusting their cost structures to stabilise profitability are making it difficult to determine their level of sustainability in the course of financial due dili­gence conducted as part of an M&A transaction. This aspect is further aggravated by additional restrictions in freight transport, which means that many companies have to spend much more money at short notice to adjust their supply chains or face delivery bottlenecks.
 
As a means of reducing costs in the short term, many companies send their employees on short-time work and resort to rent holidays for their business premises. In addition, trade shows are being postponed and meetings are being held online, which rapidly reduces companies' adver­tising and travel costs in the era of the corona virus pandemic. Thus, estimating costs on a sustainable basis to have a reliable basis for an adequate com­pany valuation is becoming a greater challenge.
 
It is currently relatively difficult to cal­culate the purchase price on the basis of common valuation methods, such as multiples-based valua­tions, given the reasons mentioned above (decline in sales revenues, supposed cost savings, etc.). Purchase prices should therefore increasingly be made dependent on the future development of the company, e.g. by applying earn-out regulations.
 

Impact on the balance sheet

The evaluation of the balance sheet also becomes more complex as a direct result of Covid-19. Companies temporarily receive subsidies, which in the course of an M&A transaction should be examined for any repayment obligations and pos­sibly taken into account as a purchase price deduction (net debt) or otherwise considered in the purchase agreement. In addition, payment deadlines are changed, rental and lease payments suspended and liabilities postponed in order to secure short-term liquidity. This temporarily redu­ces the level of the working capital and would not be sufficient in the target company's normal course of business. To address this problem, we recommend that the buy-side incorporate a wor­king capital mechanism into the purchase agree­ment.

In general, the current pandemic is spreading uncertainty on the part of the buy-side in M&A transactions. This aspect is further aggra­vated by increasing dynamics in many markets, which can cause the earnings situation of a target company to change rapidly at short notice or make planning assumptions no longer feasible. There­fore, we additionally recommend incorporating the so-called Material Adverse Change clauses (MAC clauses), which allow the sell-side to terminate or modify the agreement if additional negative events occur.
 
In principle, the impacts of the corona virus pandemic on target companies in potential M&A transactions are very heterogeneous. While especially customer-based industries (e.g. retail and gastronomy) are under pressure due to the current restrictions, the Covid-19 pandemic has been a catalyst for already existing trends, espe­cially in the healthcare and IT industries. Remote work as well as digital processes and admi­nistration have suddenly become indispensable for the survival of institutions and companies, which means that, for example, the topic of IT security has come into even sharper focus. Business models that have been positively influenced by the corona virus should undergo careful scrutiny. In particular, the focus should be on the question of which developments really are long-term in nature so that too high a purchase price level can be avoided.
 

Conclusion

The impacts that the Covid-19 pandemic has on companies are very diverse, in terms of both earnings and the balance sheet. At the same time, market uncertainty in the area of M&A is increasing, making financial due diligence of a target company more complex and increasing its relevance. Common analyses of normalisation issues (quality of earnings) and purchase price adjustments (net debt) must be increasingly examined for impacts caused by the corona virus. In this context, risk-mitigating regulations such as earn-out clauses should also be given greater consideration.