We have seen much speculation about the impact of the Covid-19 virus. One thing for certain is that the impact on businesses continues to be felt, with ongoing disruption to normal business activity being widely expected to persist over the coming weeks and month.
How many M&A deals are currently being re-negotiated is unknown, but targets in the Search Fund space often have more mature business models compared to the typical pre-revenue healthcare or technology start-up. This means that negative impacts on revenues and free cash flow often materialize straight away.
If you are in the process of signing a letter of intent or have progressed to negotiating a sale & purchase agreement, your challenge is to protect yourself from uncertainty related to Covid-19, especially because the shape and progress of the recovery is currently unknown. At the same time, it may be very important for you to preserve a spirit of trust and co-operation with the current owner and avoid a broken deal.
If you are currently drafting the agreement, it is important to pay close attention to the material adverse event / change clauses. This may require inserting provisions which would be designed for you to exit the deal in case of significant negative consequences on the target’s financials. In a departure from normal practice, this may require the inclusion of target-specific events identified in your due diligence, rather than general economic clauses. Another negotiating tactic may be to keep the agreed headline purchase price in place, but reduce up-front payments in return for a more significant earn-out component for the owner. The latter may be easier to achieve if the timings for such deferrals can be aligned with the outgoing owner’s continued involvement with the company following the sale.
Experience shows that owners selling their business place great emphasis on two factors: (a) to agree on performance metrics for calculating the earn-out that are difficult to manipulate by the search entrepreneur and (b) an opportunity for the former owner to realize additional upside from the earnout, in case the business performs ahead of expectations.
Against the many pitfalls, experienced transaction lawyers can help you to achieve the best possible outcome in these negotiations.
Inspire Business Law Group, PC assists entrepreneurs with new business formation, guiding owners through issues including choice of entity (e.g. C Corporation, S Corporation, or Limited Liability Company (LLC), choice of jurisdiction (e.g. Delaware or California), documentation, employment issues, intellectual property issues, and initial agreements with customers and partners.
If you require any further information about starting a business, please contact Edward Grenville, Managing Shareholder, Inspire Business Law Group, PC (egrenville@inspirelawgroup.com; +415 279 0779; www.inspirelawgroup.com).
This article is provided for educational and informational purposes only and is not intended to be, and should not be construed as, legal advice.
Written by Benjamin Bartsch.