The coronavirus pandemic (COVID-19) is having a significant impact on transactions around the globe, including those supported by private equity and venture capital. This blog post addresses why due diligence will be different in these uncertain times, contains practical advice on how to deal with these differences, describes key buy-side considerations when conducting due diligence, and concludes that both buy and sell-side can benefit from enhanced cooperation.
Private equity and VC sponsors should expect due diligence to take more time than usual
Private equity and VC sponsors may have to adjust their expectations and timetables as the parties could face the following challenges:
- Creation and population of the data room could be challenging due to the limited physical availability of personnel.
- Management meetings, site visits and employee interviews could be more complicated than usual due to (international and domestic) travel restrictions and local guidelines.
- It could take longer to obtain responses to due diligence questions and Q&As as distance working may lead to certain inefficiencies and the people responsible for providing answers may have different priorities as they are dealing with the effects of the crisis.
- Responses from governmental agencies relating to due diligence of public records could be delayed.
- Lenders and warranty insurance underwriters could request heightened due diligence focusing on the risks posed by the crisis to the business in the short, medium and long term; please refer to our blog on W&I insurance during the COVID-19 crisis here.
These practical hurdles can be overcome by:
- organising meetings with management and employees by video conference;
- conducting on-site visits through drones, which can provide aerial views and evidence the size and number of assets, factories and buildings;
- using software solutions such as AI, which can help to bridge the gap between broader due diligence (due to enhanced scrutiny), on the one hand, and the reduced availability of personnel to assist with the due diligence process, on the other hand;
- entering into and discussing flexible timetables for due diligence as the overall process could take longer.
Private equity and VC sponsors should investigate the impact of the COVID-19 pandemic on the target's business
Enhanced due diligence should include an assessment of the specific impact of the pandemic on the target's business, especially if the target is active in a hard-hit industry such as the travel, entertainment, hospitality, (non-food) retail, transport and energy sectors. In addition, private equity and VC sponsors should ensure that their due diligence extends to:
- Force majeure, MAC/MAE and similar provisions in key contracts with the target's suppliers and customers, and the potential risk of losing material contracting parties
- Applicability of either best efforts obligations or performance (results) obligations and, for the former, the definition of "best efforts"
- Minimum purchase volumes or non-performance as grounds for termination by the target's suppliers or customers
- Exclusivity arrangements preventing the target's exit if its contracting party fails to perform
- Availability of alternative suppliers
- Forecasted short-to-medium term liquidity needs of the target and its ability to absorb 'liquidity swings'
- Probability of borrower covenants being breached if financing arrangements remain in place after closing
- Operational diligence (remote working policy, access to IT equipment)
- Regulatory requirements relating to employee safety
- Pension plans in light of the potential adverse impact on funding due to volatile capital markets
- GDPR compliance with respect to employees
- Special employment conditions related to the crisis (e.g. mandatory holidays, bonus ceiling, other)
Insurance and coverage
- Diligence of the target's insurance policies and the coverage of potential losses in relation to COVID-19
- Careful review of continued compliance with regulation in the event of business critical events due to COVID-19 (e.g. are there any 'corners being cut' regarding privacy and data protection (click here for earlier blog on that topic) or ESG responsible entrepreneurship)
- Assessment of 'claw-back risks' in the event of the use of state aid
Private equity and VC sponsors may wish to consider enhanced cooperation
Aside from enhancing buy-side scrutiny in legal due diligence, we believe that both transaction parties could benefit from taking a flexible position as regards timing and processes. In doing so, the buyer will have more time to conduct its diligence whilst the pressure on the seller will be somewhat alleviated should it face difficulties gathering documents and answering queries.
In uncertain times, heightened cooperation will increase the chances of bringing the deal to a mutually successful conclusion.