- June 1, 2020
- Posted by: Ramkumar
- Category: Mergers And Acquisitions
M&A Deal Structures in the COVID-19 Era
During the COVID-19 pandemic, M&A activity has decreased significantly, and first-quarter earnings statements have revealed that even the United States’ biggest corporations like Amazon and Apple were not immune to the unfavorable consequences of COVID19. Amidst all of this change, though, several transactions have still been closed. Transactions that have closed have required adaptability from both buyers and sellers to reach at imaginative transaction structures to accelerate deals over the end line. This post will further investigate how these M&A deal structures in the COVID-19 era were employed to execute M&A transactions and private equity recapitalizations.
Why Do M&A Deal Structures Have to Change?
As volumes have dwindled and revenue has declined, many dynamics have shifted within the market. Banks are reluctant to render sound financing assurances, which has made it hard for private equity investors to fund platform transactions. Banks have been a crucial part of allowing absolute valuations pre-COVID-19 by giving a competitive source of financing.
Strategic acquirers need to preserve resources to handle short-term cash flow and lines of credit for working capital. Transactions listed to close at the end of the first or start of the second quarter of this year could not close as its financial metrics substantially declined. This decline has generated substantial risk for buyers and lenders of closing a transaction based on pre-COVID-19 financials for a business undergoing a significant reduction in cash.
Buyers have three alternatives. They can close a deal at the earlier agreed-upon terms in the hope of a sharp V-shaped recovery. They can stop M&A until they’ve had a chance to thoroughly evaluate the impact of COVID-19 on both their own business and the acquisition targets. Alternately, they can strive to find a middle-ground that is enticing enough for sellers to transact but decreases some of the risk associated with closing a deal during the pandemic. While many have decided to stop M&A entirely in the short-term, others have chosen to try and find a middle ground, mainly where the transaction carries notable strategic significance. On the other side of the table, sellers have proceeded to seek deals.
Leveraging an innovative structure remains a way for sellers to lock-in a valuation today as opposed to being presented to the dilemma of future estimates post-COVID. This approach gives an opening to offload administrative duties that have increased during the pandemic and provide for personal liquidity during a time where distributions may get hindered for an indefinite period. Obtaining access to the resources of a more prominent organization is also a significant advantage. This situation has left sellers with an option to pursue an opportunity to close a transaction now else pause till their business recovers. At that point, it will be feasible to attempt and close a deal at new terms. Sensibly, the initial response to the proposal of a transaction restructuring might be that the buyer is unreasonably leveraging the pandemic to “re-trade” the transaction.
COVID-19 has placed buyers in the adverse situation of merely not pushing forward at the previously agreed-upon structure. Many transaction restructuring proposals effect by buyers in a sincere attempt to keep the transaction on record as a show of good faith to the sellers. Additionally, when structured and negotiated correctly, these new structures can be applied to achieve the seller’s crucial goals, like defending valuation and giving liquidity.
What Are The M&A Deal Structures Used?
I understand three kinds of structures as choices to present transactions in the market; all equity transactions, the usage of seller notes, and deferred proceeds.
Each structure has its kit of benefits and drawbacks that sellers need to be conscious of when examining a likely change of deal structure with a buyer.
All Equity Transaction: The most simple structure is a deal funded by all equity. With many third-party lenders withdrawing out of giving debt financing, private equity firms can fund a transaction in full straight from their investment fund. It is essential to see that this is the least common structure suggested because it nevertheless needs the most cash up-front and professes a higher risk to the investor. The advantage to sellers in this form of transaction is that it will typically end in more money at closing than other structures. But, the shortcoming of an all-equity deal is the likely re-negotiation of the purchase price in the absence of third party lending to fund the acquisition. Sellers that firmly believe that their business will bounce immediately once the pandemic is over may not be drawn in this option if it doesn’t defend the original valuation.
Seller Note: A seller note is a form of debt financing whereby the seller agrees to delay a portion of the purchase price and earn that share in a list of installment payments with interest. A seller note can get used to replacing the commitment of a third-party lender. It is an excellent way to preserve the overall valuation and still maintain meaningful cash at close. The strategy for most transactions using a seller note will be to refinance the debt once the business returns to normal. Using a seller note is not without risk. Seller notes are generally unsecured, and if the company is unable to service the bill or refinance the debt in the future, sellers may never receive or only receive a portion of their deferred proceeds. In situations where sellers have firm conviction the business will recover following the pandemic, a seller note can be a valuable tool to bridge the gap between the cash a buyer can provide at closing and the overall valuation of the transaction, ensuring that the seller preserves the assessment of the business.
Deferred Proceeds: The most complicated option is structuring in deferred proceeds. These are transactions where the purchase price gets spread out over some time, usually with underlying metrics and objectives that trigger added payments. It is comparable to the seller note in sharing the idea of deferring purchase price. However, there is more flexibleness in terms of how and when the deferred purchase price gets rewarded. Typically, sellers will earn a part of the cash purchase price at close between 25-75%, with the balance paid over an agreed-upon timeline when specific targets get met, typically estimated within 18 months of closing. The goal is that once the market returns to 100%, the sellers have gained the purchase price in full. This structure enables the seller to maintain valuation while building liquidity out of business during this downturn.
These types of transactions can be challenging to structure from a legal standpoint, but with decent guidance from legal counsel, there are pliant ways to realize this structure. A deferred structure is an attractive way for sellers to protect valuation without inevitably having to provide seller financing.
While there remains skepticism within the market during these unusual times, motivated parties will proceed using innovative transaction structures to close M&A deals amidst challenging operational conditions. The above alternatives will not be a reasonable answer for every transaction. When properly implemented and negotiated, consequently, they can be a helpful tool to arrive at closing while protecting as much of the original terms of the deal as possible.