A little under a year ago M&A attorneys feared the global lockdown in response to the coronavirus pandemic might bring deal activity to a halt.
Instead, transactional work in the US quickly resumed and is showing no signs of slowing down, helped along in part by merger agreements that largely held up under pressure, a surprise increase in face-to-face negotiations and a market eager to transact.
“This summer M&A came back in a frenzy,” said Michael Woodard, the chair of McGuireWoods’ M&A practices, who added that his team was pushed to the limit in 4Q20 to staff all of the deals they had in progress.
US deal announcements steadily gained each month last year from a low in April to reach 580 in December, according to Mergermarket data. The fourth quarter saw over 130 more deals announced than during 4Q19, though for the overall year 2020 still ended with 800 fewer transactions.
Marni Lerner, head of Simpson Thacher’s private equity M&A practice, said that in 2020 the market figured out how to resolve the challenges created by the pandemic and returned to executing on deals.
Lerner and other attorneys said the activity looks like it will continue into 2021 for strategics and financial sponsors thanks to readily available financing, buoyant equity markets and buyer confidence.
“It’s been an incredibly robust time” for deals, said Kirkland & Ellis M&A partner David Feirstein.
Goodwin M&A partner Joshua Zachariah said deal parties now have visibility on how companies are responding to the pandemic and practitioners have a good handle on what parameters they need to look at when conducting due diligence.
“Sponsors are not slowing down,” said Debevoise & Plimpton M&A partner Christopher Anthony. In a sign of how competitive the market has become, Anthony said he is seeing parties attempt to preempt auctions after “realizing they have to do this to win.”
Material face time
Jonathan Levitsky, also an M&A partner at Debevoise, said the robust activity is notable given that it continues to not be the easiest time for clients to strike deals due to ongoing limitations on in-person meetings. “Zoom is not the same as having dinner with someone,” he said.
Despite closed offices and canceled travel plans, a number of attorneys said the abrupt change to remote work last March counterintuitively increased the number of face-to-face negotiations between advisors and clients as counter parties switched from conference calls to video to discuss deals.
“I’ve seen some clients more during the pandemic than before,” joked Lerner.
Attorneys said they do not believe the switch in communication formats has changed the outcome of negotiations but has in some cases made talks more cordial and faster.
“It has turned counterparties into human beings rather than oppositional voices on the phone,” said Morrison & Foerster’s Spencer Klein, who co-chairs the firm’s M&A group.
“It may impact the amount of time people are willing to negotiate. They’re less likely to fight for points on irrelevant issues when face-to-face,” added Anne Lieberman, an M&A partner at Cooley.
At the start of the pandemic, many buyers and sellers wondered if merger agreements struck pre-Covid would hold up under the strain of lockdowns and panicked financing markets. Most did, with only a few disputed transactions winding up in court, most of which settled prior to trial.
Now almost a year into the ordeal, attorneys said deal parties have figured out how to modify agreements to account for risks posed by the pandemic with most of this risk shifted to buyers.
Changes to agreements primarily lie in making the pandemic an explicit carve-out in material adverse effect clauses and providing sellers greater flexibility in interim operating covenants to deviate from pre-pandemic business practices, attorneys said.
“The changes brought on by Covid have not been material. Yes, you might add a covenant. Yes, you might ask for an extra schedule, but it’s really lawyers trying to overthink things,” said Goodwin’s global chair of M&A, Stuart Cable.
Attorneys said they are not seeing the 2020 crisis push buyers and sellers to more explicitly lay out the conditions that would allow a buyer to terminate an agreement.
Kimberly deBeers, head of the M&A group in Skadden’s Chicago office, said she has been in some discussions about whether it is possible to quantify what constitutes a material adverse effect but has not seen parties add numerical MAE definitions to merger contracts.
Cooley partner Ian Nussbaum said MAE language is inherently vague but, on the flipside, since the clause carves out categories of events that do not constitute an MAE, a buyer can use it to make clear what risk is seller risk.
Still, he said there is an inherent risk for a seller in making an MAE definition too specific by tying it to some numerical metric and losing the high bar established under Delaware law for a buyer to show an MAE.
Even in deal disputes that turn on operating covenant breaches, existing customs in drafting merger agreements help reduce the risk for sellers, said Robert Miller, a Professor of Law at the University of Iowa who has studied the issue.
Miller said that parties can mitigate risk from future events like the pandemic by exercising the option to request consent for operating out of the ordinary course or using language in contracts to specify that only “commercially reasonable efforts” must be made by the seller to operate in the ordinary course. Neither of these tools is novel, he noted.
One area where sellers have agreed to shoulder risk is the repayment of loans taken out from the federal government’s Paycheck Protection Program, said David Birke, co-chair of the M&A practice at Akerman.
Under the program established last spring to help small and medium-sized businesses survive the pandemic, companies receive loans from banks that are forgivable by the government at a later date if they meet certain criteria for how they use the proceeds.
If a PPP borrower agrees to sell in the interim, the buyer at closing typically subtracts the loan amount from the purchase price and places the funds in escrow with the PPP lender, who later releases the funds to the owners of the selling company if the loan is forgiven or uses the funds to repay the loan in the event the seller does not qualify, said Birke.
On a broader level going forward, Alston & Bird partner Tony Balloon, who specializes in cross-border transactions, said he expects deal makers will think more about macro factors like geopolitical instability that could pose a risk to mergers, especially for transactions that are expected to take a long time to close.
Top of mind in 2021 will be the Democrats’ control of the presidency and Congress, attorneys said, with open questions about how tough a line the new Biden administration will take on antitrust and national security enforcement and if Congress will raise taxes.
Despite this uncertainty, Morrison & Foerster’s Klein said he is not seeing deal makers pull back from pursuing transactions. Several other attorneys agreed with this sentiment.
Goodwin’s Cable said that he expects antitrust reviews will be tougher going forward but added that it will take time to see exactly how the Biden administration will approach enforcement.
Some sellers rushed to close transactions by the end of last year to lock in 2020 tax rates; the same phenomenon could repeat this year if Congress passes tax reform that is not retroactive, attorneys said.
All-purpose acquisition market
McGuireWoods’s Woodard said he predicts there will be an increase in creative deal structures in 2021 ranging from earn-outs and minority investments with buyout rights to joint ventures.
At the same time, Klein said the M&A market is so strong that many sellers have negotiating leverage to secure complete buyouts and do not need to rely on alternatives structures.
A notable factor driving the sellers’ market is the rise in 2020 of special purpose acquisition companies as serious buyers, attorneys said.
Sellers “now see SPACs as a real alternative” to a sale or IPO and have greater confidence in the structure, said Michelle Gasaway, a capital markets partner at Skadden.
SPACs raised a record USD 82bn in capital last year in 248 IPOs, according to Dealogic data. January is already proving busier than any month in 2020 with over USD 22bn in SPAC issuance. So far this month, over 100 SPACs have announced deals with targets valued at over USD 180bn in aggregate.
The sudden burst in activity has raised some fears that the SPAC market is turning into a bubble.
Goodwin’s Zachariah said he believes SPACs will prove to be a long-term phenomenon given the volume of capital moving into the space and the increased sophistication among SPAC sponsors.
One emerging theme in the market is SPACs pitching acquisition strategies focused on specific areas like environmental, social and governance issues, women-led businesses and niche subsectors of technology, Gasaway said.
Even with so many SPACs scouting for deals, Gasaway said she does not get the sense that competition for targets is discouraging new SPACs from entering the market.
Over 85 SPACs are currently on file with the SEC and have not yet priced their IPOs, according to Dealogic data. 70 of these SPACs filed their S-1 in January.