From potential cartel behaviour to repaying government loans, deal teams should remain alert to lingering issues rooted in a company’s response to the pandemic.

By Alexander Crosthwaite, Tom Evans, Sebastian Pauls, David Walker, Maarten Overmars, and Catherine Campbell

The recovery of the European PE market since the early days of the pandemic has been impressive — from US$114.8 billion in value and 794 deal volume in H1 2020 to US$226.8 billion in value and 951 deal volume in H1 2021. Allowing for suggestions of market bifurcation and varying treatment of COVID-19 winners and losers, deal processes for resilient assets (and even for less obviously attractive assets) are often extremely competitive, and valuation multiples continue to rise. But what of the longer-term changes that COVID-19 brought to PE acquisitions? As dealmakers return to the office and in-person negotiations, we consider four “long COVID” changes for PE dealmakers, and reflect on how these changes have manifested in recent deals.

Fight Brain Fog and Examine the Business’ Response

While many may prefer to forget 2020, dealmakers need to examine each target’s response to the COVID-19 crisis. Standard diligence now extends to the practical, legal, and commercial impacts of COVID-19 on the business, to gain a clear understanding of what happened and associated risks. The need for focused diligence is supported by the expectations of W&I insurers, with insurers particularly interested in commercial matters such as contract re-negotiations, delays in performance, and amendments to/termination of contracts. Early initiation of the W&I process is recommended.

Understanding how the target made use of government schemes, how workers were paid, and whether there were irregularities in the application for and use of scheme funds, will be key from both a repayment and compliance perspective. Multiple jurisdictions are reviewing recipients of government funds, including use of government-backed loans, subsidies, or financial support. In particular, furlough scheme use has come under focus in recent deals. Even if schemes were accessed legally, we have seen businesses opt to repay furlough monies, particularly if the company remained profitable through the pandemic. PE sponsors need to think about reputational issues in this regard.

Avoid Heart Palpitations by Considering Value Early in the Process

Many companies are holding significant amounts in COVID-19 loans and subsidies, and may store monies in separate accounts as they wait to find out how much needs to be repaid, or if loans are converted to subsidies. Purchasers are likely to seek a deduction from the acquisition price for any COVID-19-related support that may need to be repaid. If the position is uncertain, vendors may push for contingent consideration if the company is allowed to keep the support or if government loans are forgiven.

Post-Closing Issues That May Cause Poor Sleep

Deal teams should remain alert to lingering issues rooted in the business’ COVID-19 response. For example, in the rush to act, businesses may have engaged with competitors, posing a risk of cartel behaviours. Warranties are often requested, including that the target has put commercially reasonable COVID-19 prevention measures in place, and that the target has not applied for further government subsidies.

Expect Joint Pain When Transferring Deal Risks to Deal Terms

Transferring COVID-19 risk into deal term protections in the current highly competitive M&A market is challenging, requiring dealmakers to triage and prioritise. Many recently seen COVID-19 clauses favour the seller. Examples include statements that the purchaser has investigated COVID-19 thoroughly during the diligence process, that the company’s past COVID-19 actions are satisfactory, and that COVID-19 actions taken between signing and closing are carved out from gap controls. Even without a MAC, buyers on continental European deals have been expected to explicitly acknowledge that the SPA has been signed during the COVID-19 pandemic and that the purchaser is not able to rely on force majeure or other termination rights for unforeseen circumstances.