When the last of the cool spring days are behind us, stay-at-home orders are lifted, and M&A activity begins to resume in earnest, the high of the seemingly unending “seller’s market” of the past few years may very likely give way to an environment where buyers will be seeking bargains, not sky high valuations. In this new paradigm buyers will look to dampen sellers’ expectations and justify lower valuations for acquisition targets. One area we expect buyers to be laser focused on in an effort to deflate an acquisition target’s purchase price will be the risks and liabilities arising from the COVID-19 pandemic of 2020.
While we know it will be tempting for sellers to make blanket disclosures to buyers about the impacts of 2020 on their businesses – reminiscent of broad public company risk factor disclosures that were common to describe the impact of the 2008 financial crisis – experience teaches us these broad, imprecise disclosures will do little to assuage buyers’ concerns and preserve value for sellers. Instead, sellers who have an encyclopedic knowledge of their businesses and are in a position to meticulously describe all of the ways that the COVID-19 pandemic has and may impact their businesses will be in a far better position to instill confidence in buyers and withstand buyers’ attempts to haircut purchase prices for vague “coronavirus concerns” than those sellers that lack that deep knowledge and make those blanket disclosures.
So how can a seller tackle the enormous task of identifying and cataloguing the impacts of the coronavirus outbreak on its business now in anticipation of a future sale? One of the most effective ways a seller can attack this difficult task is to use customary representations and warranties from a typical purchase agreement as a guide to identify, categorize and quantify the impacts. To help guide our clients in this process, we are breaking down the representations included in market-standard purchase agreements and asking our clients to consider various scenarios where COVID-19 may have impacted their business. Here’s a chart version of this thought exercise to help you track those impacts and hopefully make those thoughtful disclosures.
| Representation and Warranty |
Items to Track for Potential Disclosures |
| Organization; Capitalization |
- Internal restructurings undertaken during pandemic
- Changes to organizational documents
- Changes to capital structure or investments made during pandemic
- Consider if all Delaware or other annual reports were timely filed (Delaware due March 31)
- Additional state presences established during the pandemic, including through telework
|
| Power / Authorization |
- Was a quorum of directors available and confirmed?
- Were any emergency board meeting provisions invoked or emergency board meetings held?
- Consider other organizational compliance matters (changes in directors and officers)
|
| No Conflicts |
- Sale restrictions under credit facilities
- Obligations under guarantees
|
| Taxes |
- Benefits claimed under the Families First Coronavirus Response (Families First) Act or the Coronavirus Aid, Relief and Economic Securities (CARES) Act (e.g., tax credits claimed, payment of taxes deferred, losses carried back or new tax elections made, and analysis of state conformity or decoupling with those federal provisions), and any applicable state or local tax incentives or benefits provided independent of federal law
- Was the 2020 tax return (which might reflect exceptionally large losses) filed?
- Were tax returns for prior periods filed or were tax refunds for prior periods otherwise claimed?
- Impact of teleworking on state and local tax matters (including employer withholding, unemployment insurance, and general nexus and jurisdiction to tax concerns)
|
| Tangible Personal Property |
- Sale of any material tangible personal property
- Leases of personal property following sale of items
- Liens placed on any personal property
|
| Intellectual Property |
- Violation of employee invention assignment agreements
- WFH IP development
- Expiration of licenses
- Sufficient enterprise licenses to cover WFH
|
| Real Property |
- Notices of defaults under mortgages
- Notices of breaches under lease agreements
- Waivers of defaults or breaches
- Amendments to leases or mortgages
|
| Material Contracts |
- Notices of breaches or defaults under material contracts
- Waivers of breaches or defaults under material contracts
- Notices of forbearance
- Notices of termination
- Amendments specifically related to COVID-19
- Credits granted for service level failures
- Impact of amendments or waivers on MFNs
- Maintenance obligations under capital leases
- Impact of exclusivity provisions on ability to find other alternative vendors
- Impact of vendor bankruptcies on businesses
|
| Environmental |
- Issues arising during WFH periods that went unchecked
- OSHA compliance
|
| Employees; Labor Matters; Employee Benefit Plans |
- Compliance with employment and leave laws (including those put in place as a result of the virus, such as the Family First Coronavirus Response Act) related to furloughs, layoffs, paid sick leave, etc.
- Communications with employees or former employees related to furloughs, layoffs or working conditions during pandemic.
- Changes to collective bargaining agreements
- Impact of teleworking on labor, employment, and benefits matters (including security of information and pressures to move towards more teleworking in the future)
- Impact of reductions in hours to hourly populations, including for overtime and benefit eligibility, as well as Affordable Care Act compliance
- Changes to compensation (including pay cuts, failure to meet performance and incentive targets and underwater equity compensation)
- Changes to benefits (including decisions to freeze or eliminate certain benefits or plans)
- Threatened or filed claims relating to violation of employment or leave laws or changes to working conditions, compensation or benefits
- Specific challenges related to vulnerable populations of employees or employees of hard hit industries
|
| Insurance |
- Cancellation of, and changes and exclusions to, policies (including increases in premiums)
- Claims made under any policies related to COVID-19
- Claims covered under any policies related to COVID-19
|
| Compliance with Laws; Permits |
- Compliance with executive orders (state and city level) related to COVID-19 (e.g., stay-at-home orders)
- Penalties for violation of executive orders
- Communications from governmental authorities related to any violations with laws or permits related to COVID-19 orders
- Impact of government office closures
- Compliance with reporting obligations
|
|
Privacy/Security
|
- Data breaches
- Breakdown of systems performance
- Material loss of data
- Physical breaches of security
- Violation of security obligations under material agreements
- Business continuity plans
|
| Litigation |
- Communications related to threatened litigation arising out of COVID-19 related items
- Claims made against or made by Seller related to COVID-19
- Impact of court closures
|
| Financial Statements |
- Changes to accounting methods
- Impact of deferred expenses
- Bad debts
- Monitoring the impact of changes to accounting standards
- Notices and advice from accountants related to impact of COVID-19 on financial statements
|
| No Undisclosed Liabilities |
- Liabilities arising from COVID-19 related litigation and contract breaches
- Impact of revenue interruption on results of operations
|
| Absence of Changes |
- Winding down of businesses / business lines
- Disposition of assets
- Restructurings or reorganizations
- Closing of locations / specific operations
- Termination of critical contracts
- Major supply chain disruptions
|
| Related Party Transactions |
- Intercompany loans
- Centralization of certain functions
|
In addition to tracking COVID-19 impacts based on the market-standard reps and warranties, we are encouraging our clients to prepare to make more pointed disclosures for matters that may already be covered by some of the more general representations above (e.g., impacts of the pandemic on revenue, expenses and the bottom line; employee furloughs and terminations; supply chains and service level agreements) and new disclosures for matters that may be addressed in new representations we see emerge in negotiations going forward (e.g., WFH experience; business continuity plan experience; systems redundancy, succession planning and emergency governance provisions; CARES Act loan terms and related issues; and accounting standards changes).
The chart and our list above aren’t intended as a comprehensive index of every possible disclosure that a seller should consider in tracking its coronavirus related risk and loss in contemplation of a sale – truth be told, each seller will need to carefully consider the target’s industry and particular business. Still, we believe these materials will give sellers a good guide to track this pandemic’s impact on their businesses and, by doing so, will arm sell-side deal teams with the information, negotiating tools and leverage to push back against the imputed or explicit discounts to purchase price buyers will be seeking in the new world after this pandemic. After all, preparation is a key component to success.
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