Out-Law Analysis | 18 Jun 2020 | 8:11 am | 4 min. read
The Coronavirus pandemic has already had an enormous impact on M&A transactions in the technology industry. And after two months of paralysis it will act as a driver of digitalisation in the European market and change both negotiation methods and the drafting of contracts.
After many notable tech M&A transactions in 2019 such as Google buying Fitbit, Salesforce acquiring Tableau and ClickSoftware and PayPal absorbing Honey, many market observers thought that 2020 would also be a big year for tech M&A.
In early 2020 this appeared to be true, but the Covid-19 pandemic put an end to that as the industrialised world held its breath more or less completely, not knowing what to expect and how to deal with the challenges of coronavirus.
The biggest technology companies - Alphabet, Amazon, Apple, Facebook and Microsoft – have bucked the trend, going on shopping sprees. This, however, seems to be an extraordinary effect on the back of hundreds of billions dollars of cash that these companies had available.
The impact of coronavirus is likely to differ substantially in different parts of the technology industry. We are likely to see a boost in activity and a rise in the number of M&A transactions in software, e-industries such as e-commerce, e-pay, e-learning, e-gaming and e-health as well as data rich industries, including data centres, data and cyber security, virtual conferences, data analytics and logistics. New approaches and actions adopted within and post the global pandemic will accelerate these markets resulting in more M&A transactions.
Sellers of well-run targets in these buoyant markets will benefit from higher valuations. According to a survey conducted by SMF Schleus Marktforschung on behalf of Pinsent Masons. It found that while the valuation of 64% of the companies involved in a M&A deal during the Covid-19 pandemic fell, the valuations of 27% of companies actually rose.
On the flip side, as in many crises there will be consolidation, and distressed tech M&A will see more transactions. Lower stock market prices will also drive the number of hostile take over attempts in public tech M&A. Investors from geographies which come early and fast out of the crisis will try to pursue bargain tech M&A opportunities in geographies which are slow in their recovery.
In order to avoid risks in these unpredictable times, the M&A parties should prepare themselves better than ever for the planned transaction, making sure that contracts take account of the changed situation.
The pandemic could have an impact on the structuring of transaction contracts. Buyers will require specific protection from hidden risks in share deals and the risk of a claw-back of assets by insolvency administrators in asset deal structures.
Provisions on merger control should take account of the fact that procedures can be significantly delayed, especially procedures not yet formally notified. In the drafting of contracts buyers and sellers should pay attention that the relevant deadlines have been met. Agreeing on more realistic long-stop dates can help reduce this crisis-related delay.
Terms and conditions in tech M&A transactions most affected will include material adverse change (MAC) clauses. Due to the Covid-19 pandemic, MAC clauses might become much more important in tech M&A deals than before, as they allow the buyer a right of withdrawal in case of a material and substantial deterioration of the target company's assets or its financial situation between signing and closing. Coronavirus means that many buyers may want to make use of MAC clauses. According to the survey, 49% of M&A deals have been more buyer-friendly due to Covid-19, while 32% percent have been more seller-friendly and 19% neutral.
Certainly, there will also be more negotiations around purchase price adjustments and earn-out mechanisms in order to achieve a distribution of the economic risk associated with the selling or buying of a company.
In general, the economic risk associated with the object of purchase is transferred in full to the buyer on conclusion of the contract. In order to change this, the parties – in particular the buyer – should pay attention to the structure of the purchase price regulations and not to agree on a fixed purchase price, but this through certain purchase price mechanisms, for example closing accounts can be included in the contract.
With the legal institution of the closing accounts, the contract parties first agree on a basic purchase price, which after conclusion of the contract is based on the basis of a pro forma balance sheet as at the commercially effective date of the transaction. The final purchase price will be determined, when the closing accounts are set up and have become indisputable. It is therefore a mechanism to determine a purchase price which is able to reflect economic developments between signing and closing.
Further, earn-out clauses are another mechanism to avoid a fixed purchase price. Earn-out clauses ensure that the purchase price is divided into a fixed and a variable component. The payment of the variable part is delayed by between one and three years and its amount may be adjusted in relation to the future development of earnings, or other factors, and may depend on certain conditions stipulated in the purchase agreement.
On top of all the above we are likely to see a number of very practical implications for how tech M&A transactions will be planned, signed and closed. Timelines of how to prepare and pursue due diligence will be affected. Looking at social distancing and home office requirements, it is easy to see that companies face practical challenges. Virtual elements will not only be routine in due diligence but become even much more prominent in all steps of the way. Virtual meetings to negotiate, sign and close transactions will become more the rule than the exception. Encryption of documents and electronic signatures will be more important than ever before, as many documents that were formerly submitted in physical form will now be transferred digitally. Caution is required when selecting the correct electronic signature. Lawyers and clients will also use electronic signatures more often and accordingly will adapt their approach to verifying the identity of individuals.
As a result of the Covid-19 crisis we can expect further regulatory restrictions for foreign direct investments (FDI) to come into effect in most European countries, specifically in Germany, and regulatory practice to be tightened considerably. It is also likely that there will be a push to tighten FDI regulation within the EU generally, with the aim to make the EU as a whole more resilient and more self-sustained.