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Buying and selling businesses is always a big deal.
M&A transactions are often months, sometimes years, in the making. They often require careful preparation of a business for sale, including aspects such as key financials and preparation of information memoranda for a seller, and due diligence, forecasts and integration plans for a buyer.
When all of that is married up and a buyer and seller are on the same page in principle, the main (and often most difficult) negotiations turn to money. Not just how much, but how it is to be paid, when it is going to be paid, what security is available to a seller, and if/how it is to be adjusted in the future, to reflect the apportionment of risk between buyer and seller re the financial performance of the business following the sale.
There are many ways to value a business. Ultimately it is about the balance between what a seller will accept and what a buyer will pay, but there are several accepted norms, such as the involvement of some or all of EBITDA or similar, multipliers thereof, net assets and their interplay with the ‘normalised’ working capital requirements of the business. Most M&A transactions will have at least some financial basis in one or more of these principles.
From a seller’s perspective, they are selling what they have built up. From a buyer’s perspective, they are usually buying something of future value – an expectation of a future revenue stream based on historic trends and financial forecasts for the foreseeable future. All valuations, therefore, involve some degree of past performance and future expectations.
With this in mind, mechanisms are often built in to balance the expectations of buyers and sellers. This often takes the form of pages of warranties, completion accounts, earn out provisions, deferred consideration, consultancy periods and more. All of these mechanisms bring future performance into the fold.
Accordingly, M&A transactions will usually go most smoothly when the future can be accurately predicted. Stability and growth often help these mechanisms work for buyers and sellers – when forecasts become reality.
What is the worst thing for deals with a basis in forecasts and future expectations? Something unforeseen. Even worse, something unprecedented.
Enter 2020. The year that has brought new words and phrases into our lives perhaps more than any other. When ‘new norm’ and ‘unprecedented’ are a couple of the most used words and phrases of the year, it does not bode well for arrangements with their root in future expectations.
So, what does this mean for M&A transactions? Time will tell, but it is already clear that the economy has been substantially hit by the COVID-19 pandemic. Q2 saw a 20.4% shrink in the UK economy, the worst on record. It doesn’t get much more unforeseen than that.
In the context of M&A transactions, this means that for many deals based on multipliers of EBITDA completed last year or even in the first part of 2020 are likely to bear little resemblance to the position a year later. And that first anniversary is often a trigger for adjustments to the agreed price.
Where deals include earn outs, adjustments or deferred consideration based on subsequent post-sale performance, sellers will potentially lose out. Where they don’t, buyers may now feel they have overpaid. On deals where buyers and sellers once had similar expectations and objectives, they could now be way apart.
Where the interests of buyers and sellers suddenly conflict, the scope for disputes hugely increases. Aggrieved buyers look for ways to retrospectively chip the price. Aggrieved sellers look for ways to maximise their returns.
Disputes are likely to become more commonplace in the last quarter of 2020 and into 2021, as deferred consideration and earn out periods from last year come to trigger points. Many accounting exercises have expert determination clauses and we are likely to see an increase in their use in the coming months.
Wider than this, however, is the likelihood of an increase in claims against sellers, such as warranty claims, indemnity claims and other general allegations of misrepresentation and the like. Buyers will often use such claims as a bargaining chip when it comes to the time for payment of deferred consideration.
In the SME transaction space, in particular, periods of consultancy are often agreed whereby the sellers stay in the business for a period of transition, sometimes as part of earn out arrangements. This brings its own challenge, when buyers and sellers have to work together, but are aware of the likely dispute ahead because of a downturn in results against the agreed targets.
Such fallouts also raise the likelihood of post-sale restrictive covenant arguments, as sellers may look to compete with their former business if they haven’t been paid in full for the sale. Equally, where sellers have retained security for future payments due, there is scope for battles for control between buyers and sellers.
All things considered, 2021 is likely to be a year of potential M&A disputes. Buyers and sellers should be prepared, and their advisors should be alive to this at an early stage.
When M&A disputes arise or are on the horizon, more so than any in any other types of litigation, the right advice and expertise is key.
As is objectivity; the benefit of a fresh pair of eyes can be crucial when such lengthy and complicated documents are involved. Whilst it may be natural to go to the original transaction lawyers, those who drafted the documents may not give you the clear and objective advice required.
Early preparation is also crucial to set up the best bargaining position, whether you are the buyer or seller. Warranty claims will normally have short periods for notification of claims, and accounts exercises will normally have deemed acceptance provisions, with timescales and requirements for notices often being specific and complex. Swift, decisive and careful advice and approaches can be the difference between success and frustration.
Our top tier Legal 500 ranked Dispute Resolution team, one of the largest and most experienced in the Midlands, specialises in corporate transaction disputes. So, when you instruct us, you will receive years of relevant experience on your side.
We have a fantastic record of achieving resolutions without formal proceedings, but where that is required, we have a wealth of experience in disputes in the specialist divisions of the High Court, arbitration proceedings and expert determination proceedings.
Hopefully, your 2021 will be better than 2020, which is sure to go down as one of the worst years in modern history. But if you end up in dispute over a deal made in better times, remember the key principles:
For some, disputes will be inevitable. Where they occur, we will help you obtain the best possible outcome.
Please note, the information included in this update is correct at the date of publishing.
If you have any questions relating to the article or wish to discuss any future transaction, please contact us on 01332 226 480 or complete the form below.
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