- Kevin A. James
How to Sell a Business in the COVID-19 Environment
The outbreak of COVID-19 is having a significant impact on companies. Many business owners are asking how do I sell a business, or acquire a business in this environment. Companies or individuals entering into new transactions during this period face many challenges due to disruptions in the market, government mandates in response to the COVID-19 outbreak, and related changes in federal and state law and regulations.
This article identifies key issues to consider when entering into a business transaction that may be impacted by the COVID-19 outbreak, including issues related to due diligence, drafting and negotiating the acquisition agreement, and closing logistics.
Key Issues Affecting How to Sell a Business During Covid-19
In addition to the traditional due diligence, the buyer needs to conduct a more thorough investigation of how the COVID-19 outbreak has affected the business they are looking to acquire, including the impact of travel restrictions, social distancing restrictions and guidelines, and other government mandates. Areas of special concern may include:
Supply and distribution chain risks
Workforce and health and safety policies and procedures
Business continuity and emergency preparedness
Terms of material contracts, such as termination rights and material adverse change (MAC) and force majeure provisions, and
Compliance with debt documents
Social distancing restrictions and guidelines and other government mandates may make it more difficult for the parties to conduct due diligence. Alternative means may be needed for on-site visits and in-person management presentations. For sellers, it may be difficult to compile due diligence materials because many offices and other business locations may be closed.
Drafting and Negotiating the Agreement
In addition to key negotiated issues, the parties should focus on the following factors which may be specifically impacted by the COVID-19 outbreak:
Purchase price and valuation issues
Because the impact of the COVID-19 outbreak remains uncertain, it is difficult to properly value the target company at the time of signing, especially if there is a delay between signing and closing. The buyer can address this by including:
Purchase price adjustments. Although deals often include adjustments for net working capital and debt, the buyer may want to add post-closing adjustments based on other factors, such as revenues and earnings. If the seller agrees to additional adjustments, it should try to cap the amount by which the buyer can reduce the purchase price; and
Earn-outs. The buyer may consider an earn-out if the parties cannot agree on the value of the target company. However, there are several difficult issues underlying an earn-out that can result in complex and challenging negotiations. Earn-outs also have a high potential for disputes.
The parties should consider whether the MAC definition needs to address the COVID-19 outbreak or, more generally, pandemics, epidemics, disease outbreaks, and other public health emergencies. The seller wants to include these as carve-outs to the MAC definition so that the buyer cannot use conditions caused by the COVID-19 outbreak to terminate the transaction. The buyer may argue that the additional carve-out is not needed because the impact of the outbreak is already covered by other carve-outs typically included in the MAC definition (such as general economic or industry conditions). However, if the buyer does agree to include the additional carve-out for the COVID-19 outbreak or pandemics in general, it should also include an exception for disproportionate effects. The seller may then request to further limit the disproportionate effects exception to the COVID-19 outbreak or pandemics MAC carve-out to solely any material and incremental disproportionate impact. ]If the buyer wants to improve its chances of proving a MAC, it should specify a specific, objective test for what constitutes a MAC (for example, if revenues fall below a certain amount or the company loses a certain number of customers) or add a related closing condition.
Representations and warranties
The parties should focus on the representations and warranties most affected by the COVID-19 outbreak and tailor them accordingly, such as:
relationships with customers and suppliers;
accuracy of financial statements and adequacy of internal controls;
status of material contracts;
collectability of accounts receivable;
quality and adequacy of inventory;
compliance with applicable laws, including employment, employee benefits, and new regulations related to the COVID-19 outbreak;
absence of undisclosed liabilities related to the COVID-19 outbreak;
business interruption insurance and continuity and emergency preparedness (this is not a common representation, but may be one that buyers seek in the future).
During negotiations, the parties should pay particular attention to knowledge and materiality qualifiers used in the representations and information included in the disclosure schedules.
Interim operating covenant
The parties should consider whether any exceptions need to be made to the interim operating covenant, which generally requires the seller to continue operating the target company in the ordinary course of business. The seller may need to take actions that would not be considered in the ordinary course to minimize the negative effects of the COVID-19 outbreak on the target company. In those circumstances, it may not be feasible for the seller to obtain buyer’s consent before taking this action. If an exception is included, the buyer should ensure it is drafted as narrowly as possible and includes any necessary limitations.
Because of the volatility in financial markets caused by the COVID-19 outbreak, it may become difficult to obtain financing. If the buyer plans to finance the deal, it should consider including provisions protecting it in case the financing fails. It can initially try to include a financing out in its closing conditions, so that it can walk away from the deal if its financing becomes unavailable. However, sellers usually resist taking on the risk of the buyer being unable to finance the deal. As a compromise, the buyer may propose a reverse break-up fee, which the buyer pays if it cannot obtain its financing and proceed with closing the acquisition.
Drop dead date
The parties should include a provision allowing them to extend the outside date by which the acquisition needs to close (also referred to as the drop dead date or set the drop dead date far enough in the future to not need an extension.
Disruptions caused by the COVID-19 outbreak (including travel restrictions, office closures, and other government mandates) may complicate or further delay closings of private M&A transactions. For example:
Many state and county filing offices have been closed to the public. In-person filings in those locations have been suspended. Filings by other means are still available, but the turnaround time for those filings are usually delayed. This affects closings that require a certificate to be filed (such as a certificate of merger) or a certificate to be obtained (such as good standing certificates).
If the closing must be held at a physical location, the parties may be prohibited from meeting at their chosen location because of social distancing or other government mandates. Even if the closing location is available, officers or directors required to sign the closing documents may not be able to attend.
While there may be additional challenges to selling your business during COVID-19, many clients are finding it is the right time to sell. Many business owners who were contemplating selling their business in a few years have expedited their timeline. If you have any questions about how to sell a business during COVID-19 reach out to Kevin A. James, Esq.
Kevin A. James is a business attorney in Placerville, CA. He helps business owners navigate the complex legal landscape in California with the goal of making his client’s businesses more profitable and simpler to operate. He can be reached at firstname.lastname@example.org or (530) 295-6400.