M&A in the midst of a Black Swan Event


As the devastating financial impacts of the coronavirus pandemic are felt by businesses of all sizes around the world, M&A decision makers are reviewing transactions that are currently underway for opportunities to re-negotiate financial terms or, if necessary, terminate the deal. The impact of the coronavirus will likely also alter the M&A landscape in the coming months, which will present new challenges, risks, and opportunities for those seeking to sell or purchase a business. In this article we have summarized various considerations for current transactions as well as our thoughts on the future of the M&A environment.

Transactions Underway

A purchaser may have the option to withdraw from a transaction without liability if it is clear that the pandemic will have a materially negative impact on the target company’s business.  Assuming a binding acquisition agreement has been signed by the parties with an interim period (the period between signing and closing), the following should be considered:

MAC Clause

Most purchase agreements contain a material adverse change clause (MAC) that allows a purchaser to withdraw from a deal if there is a material adverse change to the financial condition, business or prospects of the target during the interim period between signing and closing.  Unfortunately for purchasers, MAC clauses often exclude adverse changes in the general economy that do not impact the target’s business in a way that is disproportionate to other businesses operating in the same industry.

As the definition of “Material Adverse Change” (sometimes called “Material Adverse Effect”) varies widely in acquisition agreements, whether or not a MAC clause allows a purchaser to back out of a deal is highly dependent on how the clause is drafted.

Representation & Warranties

Representations and warranties, which are typically the largest part of an acquisition agreement, are inextricably linked to the agreement’s disclosure schedules, closing conditions and indemnity provisions.  Given the sudden and rapidly changing impact of the pandemic on most businesses, representations and warranties about the target and its business that were true on signing may no longer be true on closing.  Depending on the terms of the acquisition agreement, the vendor’s inability to confirm that its representations and warranties are true on closing may give the purchaser the right to terminate the agreement or close and seek damages under the indemnity provisions.

Interim Period Covenants

It is customary for acquisition agreements to include a number of interim covenants requiring the vendor to continue operating the target business in the ordinary course consistent with past practice until closing.  Given we have already seen many businesses close or severely limit operations due to pandemic related restrictions, impacted vendors will be in breach of their interim covenants to operate which may provide purchasers the right to terminate or a claim for damages.

Conditions to Closing

Acquisition agreements invariably include a long list of conditions to closing, including requirements that all pre-closing covenants have been fulfilled by the vendor and all vendor representations and warranties are true on closing.  As noted in the discussion above, these conditions may give a purchaser the means to back out of transactions that are no longer desirable.

The New M&A Environment

  • The coronavirus is a black swan event of such massive magnitude that it is going to be difficult, if not impossible, to predict the medium and long-term prospects of many businesses. That uncertainty will lead many prospective buyers, financial and strategic, to adopt a wait-and-see approach.  As a result, activity is likely to slow in the short-term.
  • With the end of the long running sellers’ market, we will see lower purchase price multiples and valuations. As the financial impact of the pandemic unfolds, we suspect many sellers who are not prepared to ride out the coming downturn will quickly lower their sale price expectations.
  • Buyers with substantial cash will be well positioned for opportunities that arise over the coming months. Cash will provide these buyers with a significant negotiating advantage.
  • Buyers with fewer financial resources may seek vendor financing, which may be the only sale option for vendors with distressed businesses.
  • Financing conditions precedent will likely become a common feature of purchase agreements.
  • We expect that post-closing earnouts will be used in many transactions to bridge the gap in purchase price expectations between the buyer and seller. Earnouts allow sellers to earn a higher purchase price if the target business performs to the agreed metrics of the earnout.  Conversely, buyers are protected from overpaying if the business fails to achieve the agreed metrics.
  • With heightened liability exposure, we are likely to see many buyers insist on buying assets rather than shares.
  • Careful and thorough due diligence will become more important than ever. Where businesses are on the verge of insolvency, a court ordered process that eliminates liens may be the safest method of proceeding with a transaction.
  • Obtaining bank financing is going to be challenging and expensive as risks rise in the coming months and quarters. Highly risk averse Canadian financial institutions will have the same concerns about the target’s businesses as the buyer.  Banks will be looking for thorough due diligence and likely additional security.  Buyers requiring financing should ensure their acquisition agreement includes a financing condition.
  • Regulatory approvals will take longer while government offices are closed and staff are working remotely.
  • Going forward, MAC clauses will be drafted to deal with the impact of the pandemic, allowing buyers to terminate if impacts are materially adverse to the target’s business prior to closing. Additionally, pandemic risk may be allocated to sellers by negotiating specific indemnity provisions.  Of course, all of this will be subject to negotiation by the parties.

With the changing M&A landscape comes heightened risk and opportunity. Managing those risks and taking advantage of opportunities will be critical in the coming months.  Please contact Aaron Singer, Teio Senda or any of the other Private Company Transactions Group lawyers at Clark Wilson LLP for further information.

For more legal analysis of how COVID may affect your business, or personal affairs, visit Clark Wilson’s COVID-19 Resource and FAQ pages