The outbreak of the Covid-19 pandemic and the lockdowns that ensued have caused widespread social and economic upheaval, with sectors across the economy feeling the impact – M&A’s have been no exception.
Firms reneging on previous agreements have meant global M&As have decreased by over 50% since April, compared to the same period last year. The downturn in activity has been most acutely felt in the US, where overall acquisitions have fallen by 90% compared to a year ago. This is due to many firms currently focussing on improving existing businesses instead of making acquisitions.
In this article, we will be looking at how M&A’s have been hit during the pandemic and why this has led to an increased focus on material adverse change clauses and private equity firms.
What are M&A’s?
M&A is an acronym for the term Mergers and Acquisitions, these are widely viewed as a consolidation of assets and would usually take place with at least one of the following aims:
- Increasing the value of a company by diversifying and therefore reducing risk
- Improving market share
- Expanding geographically
Despite the two terms often being used in unison there are subtle differences between them. A merger can be used to describe when two firms (usually of a similar size) come together and become a single entity. In this instance, the stocks of both companies would be surrendered, with the stocks of the new merged company taking their place.
Whereas, an acquisition takes place when the bidding party purchases most or all the shares of the firm that is being acquired.
Material Adverse Change (MAC) clauses
During the pandemic, we have seen a greater focus on MAC clauses, with an increasing number of buyers trying to pull out of deals.
MAC clauses are most commonly used when there is a lengthy gap between the signing and exchange of a M&A deal. Such clauses allow a party (usually the buyer in an acquisition) to pull out of the deal if a material adverse change has affected the selling company. In most cases the buyer is keen to insert a MAC clause, with the seller more resistant to the idea. Rather ironically, despite the increased focus on them during the pandemic, MAC clauses have become less prevalent in recent years.
A point of conflict between the two parties when a MAC clause is invoked is what constitutes a material adverse change. In such situations, the language used in the agreement is key, it is much easier for buyers to invoke MAC clauses when the agreement clearly states the specific events which constitute a material adverse change. For instance, if the agreement states a 25% drop in revenue of the selling company constitutes a material adverse change, and the selling firm goes on to have a drop-in revenue of 25%, it will be relatively simple to invoke the MAC clause. However, if the clause is more generic and merely makes a general reference to factors such as financial condition, operation, or liabilities of the seller, it will be much harder to invoke the MAC clause.
In the UK, generic MAC clauses are more common, however such clauses are harder to invoke and often the final decision is left in the hands of the courts. In the context of the Covid-19 crisis, it is vital to understand that external economic conditions will not be considered a material adverse change, unless the agreements clearly specify those circumstances. However, given that it’s widely agreed that the current crisis was unforeseeable prior to the Covid-19 outbreak, there is still hope for buyers who signed agreements with generic MAC clauses prior to the outbreak. Whether such clauses can successfully be invoked is only going to become clear after what would likely be lengthy legal proceedings.
Those who signed agreements with generic MAC clauses since the virus has emerged will run into issues, given that they were aware of the virus’ existence and the likelihood of economic uncertainty. If the MAC clause contains specific trigger events that have now occurred, there is an increased likelihood that the buyer will successfully invoke the clause.
Moving forward, buyers are going to be extremely apprehensive about signing agreements that do not contain specific MAC clauses. It’s likely that bidding companies may look for infectious diseases to form a part of MAC clauses. However, agreement on the exact parameters of such a clause is going to be a highly complex issue.
Why has Private Equity activity not been hit?
Private Equity firms have been amongst the most active parties in M&As this year. Despite the pandemic, they account for 16% of activity, this is the highest level since 2007. US firms have been more effective than most, with Joe Bae, co-president and co-chief operating officer of KKR (US Private Equity) stating his firm is “capitalising on the unprecedented level of volatility and dislocation in the markets to buy high-quality businesses at attractive prices”. This is a trend repeated by other Private Equity firms which see an opportunity to invest in businesses badly hit by the pandemic at relatively low prices.
The strong Private Equity activity can also be put down to other factors such as regrets following the 2008 crisis, that firms failed to act quickly enough and an eagerness not to make the same mistake twice. Private Equity firms are also planning for the post-crisis environment – given there has been an increased reliance on technology since the outbreak, there’s a strong chance we will be seeing great interest in this area.
Looking to the future there is cause for cautious optimism that M&A activity could rebound in the third quarter, fuelled in-part by pent up demand. Given private equity firms have been looking to take advantage of lower valuations its likely hard-hit areas such as retail are to be of great interest to them. However, given the current volatility and the threat of a possible second wave of Covid-19, we must remember that predictions are just that … predictions.
This article is intended for guidance only and should not be relied upon for specific advice.