When M&A’s New Normal Feels Like Hula Hooping

M&A in 2021 hit high records. They were driven by the low-interest environment, PE dealmaking fueled by dry powder, and strategic consolidation across all markets. Surging inflation, rising interest rates, soaring oil and gas prices, tougher regulation, geopolitical tensions and the resulting economic instability are all factors that are definitively shifting the new dealmaking environment in 2022. In this Strelia M&A Series, we explore some of the evolving and increasingly complex challenges of the M&A’s new normal. They basically prompt sellers and buyers to test, flex, and twirl their muscles skillfully, just as one does when hula hooping.

A 360° Due Diligence

It is true that scope-setting has always been integral to due diligence. In times of high uncertainty where buyers and W&I insurers are exposed to a myriad of evolving and multiplying risks, they are taking a 360° approach on due diligence to assess such risks from all angles. The pandemic basically triggered the start of this new normal. Since then, issues relating to supply chain, IT systems, material contracts and financial support are being scrutinized with a fresh pair of eyes—and from all perspectives.

We also see corporates developing a more systematic approach to ESG due diligence, particularly in relation to value chains and corporate responsibility. Finally, and to no one’s surprise, compliance with sanctions is becoming increasingly important. It is therefore important, as part of the due diligence, to analyze and evaluate relationships that may involve the issue of sanctions. Laws and regulations regarding sanctions and export control change frequently, so due diligence checklists should be updated continuously. Fulfilling sanctions compliance before entering into a transaction is a starting point, but it will not usually suffice because new requirements may take effect when the transaction is completed. Sanctions due diligence cannot be thorough and valid if it’s conducted in isolation because sanction regulation and enforcement substantially overlap with other regulatory areas.

More generally, and as heightened regulatory intervention is clearly here to stay, buyers must be cautious about inheriting liabilities for historical regulatory noncompliance. We do indeed see high fines for cyber and data breaches, cartel behaviors, gun jumping, and breaches of regulatory orders. This is also true for businesses that are not traditionally viewed as regulated.

Evolving key due diligence themes are likely to be subject to closer scrutiny nowadays. Buyers and W&I insurers will indeed want to understand how well the target is equipped to navigate the new normal. The 360° due diligence is also likely to impact the timing of transactions. Also, post- completion due diligence and remedial processes may be required in situations in which regulators expect ongoing due diligence and compliance. Buyers contemplating a transaction should consider that pre-completion due diligence includes not only traditional risk assessment but also an evaluation of their capacity to meet the ongoing due diligence and compliance expectations, as well as the assessment of enforcement risks when the transaction is completed.

Allocating Risk And Uncertainty

High volatility and instability likely create mismatches between the seller’s pricing expectations and what a buyer is prepared to pay. Parties should reflect on how to bridge this valuation gap. Market uncertainty will also require parties to prioritize what can be back-ended to the gap period and what is essential for signing. Also, gap periods are becoming longer to allow for regulatory approvals to be obtained. The focus on gap covenants is therefore increasing accordingly. Buyers may be seeking additional walk-away rights. Lenders may take longer to provide credit approval. Buyers will seek additional warranties, indemnities and post-closing price adjustments to mitigate the uncertainty.

We are likely to see more ESG-linked M&A deal terms such as ESG warranties and specific indemnities, or in PE transactions, the feature of ratchets to support stakeholder alignment on post-completion ESG enhancements to an acquired business. Material ESG due diligence findings could also affect the target’s value, and the buyer could use them as leverage in negotiations. Also, and in relation to sanctions, sanctions due diligence is supplemented by relevant sanctions compliance representations and warranties for the past as well as by commitments for the future if the relationship between the parties is set to proceed.

Gisèle Rosselle - Partner - [email protected]

Céderic Devroey - Associate - [email protected]

Marie-Elisabeth Dubois - Associate - [email protected]

Zie ook : Strelia

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