Tips for Negotiating M&A Deal Terms During COVID

The novel coronavirus has caused significant disruptions in the mergers and acquisitions market. Deals currently in the pipeline will almost certainly be affected. Parties contemplating a future deal may also have to anticipate the effects of COVID. Here are some of the most common transactional challenges, and what you can do to manage them.

Adjustments to Working Capital

Working capital amounts that the parties pre-negotiated might no longer work in the current environment. Dealmakers often determine working capital targets and mechanisms by averaging the amount of working capital for the most recent months—often with some adjustments. However, this method is prone to error thanks to the unanticipated once-in-a-lifetime effects of COVID. The parties must be willing to undertake a more granular financial analysis to determine appropriate adjustments. Buyers should weigh the following considerations:

• Estimated customer collections and aged accounts receivable. Treat these like debt.
• Aged accounts receivable, inclusive of non-recurring penalty payments.
• Working capital holdbacks for additional security prior to the finalization of working capital numbers.
• Valuation of inventory, particularly obsolete inventory, and slow-moving items or those with a short shelf-life.

Protection for the Purchase Price

With so much uncertainty in the economy, it’s going to be difficult for buyers and sellers to align their expectations and decide on a fair price. A number of mechanisms may help bridge the gap and bring the parties closer together.

One of the most popular is the earnout, which makes some of the seller’s earnings contingent on future deal performance. An earnout offers more security to each party. It can align incentives by protecting against market uncertainty. It shifts some of the purchase price to the future, and gives the buyer the benefit of the seller’s ongoing expertise. The parties must set specific earnout milestones and nail down precise deal details to make this arrangement attractive to both sides.

Representations and Warranties

The world of representations and warranties has rapidly evolved and will likely involve much more scrutiny, particularly for businesses that require detailed representations or specific disclosures. The parties must commit to a detailed due diligence process that helps weigh the effects of the pandemic on the target business. It is important to discuss recent events, such as:

• How travel restrictions and shutdowns affect revenue, and whether there is any way to offset these effects.
• How supply chain disruptions affect operations or the ability to fill orders.
• How decreased demand may affect revenue, and whether there is any way to either increase demand or offset these effects.

COVID-19 is an unprecedented disaster. No one has a crystal ball that can conclusively tell the future. But wise advisors have weathered storms before. They know how the economy reacts to challenges, and how these challenges can affect businesses. Anyone planning to engage in M&A should work with an advisor. Their wisdom can inform the process, reduce risk, and make a seemingly impossible transaction feel manageable. With the right advice, some companies can even use COVID-19 to their advantage.