2020 is behind us, but it’s leaving a legacy that we’ll have to deal with in 2021. For M&A lawyers in particular, here are three things to be aware of when pursuing deals in the new year.
Beware Covid-19 Diligence
The day before the deal was supposed to close, I got the call that all M&A lawyers dread: “Pencils down; the deal is off,” our client told us.
The client had been pursuing this deal in earnest for more than four months, since just after the beginning of the pandemic. We had reviewed the relevant due diligence documents posted in the virtual data room. We had drafted all of the operative transactional documents. What hadn’t happened? Why had this deal cratered?
At a technical level, the deal blew up over a late-breaking request to limit the scope of the seller’s noncompete. (Our client was the buyer.) But the cause of death was really the lack of diligence available in the Covid-19 world.
Typically, a buyer would make numerous trips to meet with a seller and would, over the course of those trips, spend more than a week with the seller. They would learn the nuts and bolts of the seller’s business. They would review financials, pore over customer and supplier lists, and discuss how best to transition and grow the business post-acquisition. All of that can be done virtually, via phone, Zoom or virtual data room.
It’s much harder to get to know someone virtually, though, and even more so to get to know the collection of people who comprise a business. The inability to travel, meet in person, and truly take stock of the seller and their business can prove fatal to a transaction.
Buyers and sellers should find new ways to connect on a personal level during their diligence process, even in our current Covid-19 filled world. If in-person meetings are not possible, perhaps individual Zoom meetings (i.e., CEO and CEO, CFO and CFO) in more relaxed environments could help both sides to get a better sense of the person across the table (or screen).
Having established a true relationship with the other party can (and often will) save a transaction when the inevitable bumps and bruises arise.
Labor and Employment Issues
Running a successful business has always been hard, and the pandemic has only made it harder. While the pandemic has brought different challenges to different industries, one common difficulty has been keeping a company’s workforce safe, healthy and productive.
Every business has had to change the way its people work, whether through the use of masks and social distancing, work-from-home arrangements, or otherwise. Those changes mean that every business has had extra opportunities to get things wrong.
Most businesses have done exactly what they should do. They’ve checked with their regulators to make sure that their workplace/workforce changes don’t create issues. They’ve crafted new policies with the help of their HR and legal departments. And they’ve kept an eye on not only how to keep their workers safe, healthy and productive but also on how to keep their businesses protected from potential claims by employees.
But not all businesses have been successful in these efforts, and potential buyers need to be on the lookout for problems in this area. Buyers should ask the difficult questions about furloughs, layoffs, compensation reductions and anything else that businesses did to survive in 2020. Knowing how the target company handled these issues will help the buyer understand risks and find solutions to those problems.
The Paycheck Protection Program offered a lifeline to businesses that had been hit hard by the economic slowdown that the pandemic caused.
PPP loans also created issues for borrowers who are acquisition targets. For example, did the PPP loan recipient comply with the restrictive covenants in its existing loan documents? Because the PPP loans were unsecured and were designed to be forgiven, many lenders were willing to grant a borrower a waiver or a consent to permit the borrower to apply for a PPP loan.
But that assumes that the borrower asked the lender’s permission before applying. Some borrowers didn’t think to do that, and may have breached covenants in their existing loan documents by receiving a PPP loan.
Assuming a borrower did clear the PPP loan with its existing lenders before applying, did the borrower actually use the loan proceeds for the specified purposes that permit the loan to be forgiven (i.e., payroll and certain non-payroll expenses like rent and utilities)?
Even if a PPP loan borrower did everything correctly, some lenders have taken the position that a sale of the borrower (either stock or assets) requires the Small Business Administration’s approval before the lender will approve the transaction. Without this approval, the loan would accelerate, and the borrower forgoes its opportunity to apply for forgiveness.
Potential buyers need to be very careful that their targets have dotted their i’s and crossed their t’s on all aspects of PPP loans. Buyers should also do their diligence on the PPP loan documents early in the diligence process to flush out any closing or change of control issues with respect to the PPP loan.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Philip Dunlap, managing partner of Balch & Bingham’s Houston office and member of the Corporate Practice, represents clients in mergers and acquisitions transactions across all industries.
David Bowsher, partner in Balch & Bingham’s Corporate, Energy and Corporate Finance & Securities practices, advises on oil and gas acquisitions and financing, mergers and acquisitions, and bankruptcy matters.