The New Normal of Acquisition Financing: What has Changed Due to COVID-19?

The outbreak of the 2019 novel coronavirus disease (COVID-19) continues to have a significant impact on a range of industries and on many organisations around the world.

Companies with existing or planned merger and acquisition (M&A) deals are facing specific challenges due to disruptions in their markets, government mandates in response to the COVID-19 outbreak and related changes in federal and state law and regulations.

Despite these challenges, large value M&A deals have continued to progress, and have been successfully completed, in the first half of 2020. One high-profile example is the successful completion by Japanese beverage company Asahi of its acquisition of Australian brewing company Carlton & United Breweries in early May 2020, which was an acquisition that included Foreign Investment Review Board approval.

Despite the current business and economic climate other companies are openly considering potential acquisitions (for example, Westfarmers has announced publicly that it has around 20 acquisition targets under active consideration) while others are swooping in to acquire businesses that are struggling during this time (for example, the potential takeover of Virgin Australia, with a shortlist of four potential bidders for the airline just announced).

As the economic, social, political and individual health impacts of the current pandemic remain uncertain, we can look to the reaction of companies, private equity funds and national superannuation and pension funds to the global financial crisis of 2008 and 2009 to give some indication of how the M&A space may react to opportunities for mergers, acquisitions, takeovers and consolidations across a wide range of industries and markets in 2020.

How the seven stages of a typical acquisition financing transaction have been affected

It is in this environment that the Practical Law Banking and Finance team has released their acquisition financing topic. This new topic provides resources for bidders, sellers and acquisition lenders to successfully fund their M&A deals during ‘normal’ and ‘abnormal’ times.

Given the current situation, the following questions arise: what does an acquisition financing transaction look like during a time of international crisis? What can lenders do to address the range of uncertainties and risks? How can the parties work together to ensure that the transaction proceeds successfully and as smoothly as possible amid the turmoil of the ‘new normal’?

COVID-19 has affected each of the following seven core stages of a typical acquisition financing transaction:

1. Term sheet review

First, a borrower receives and reviews the lender’s term sheet for the acquisition financing transaction. However, during a crisis such as the COVID-19 pandemic, this term sheet is unlikely to be binding (or any commitment letter that accompanies the term sheet will be highly conditional), as lenders face uncertainty about future capital availability and the credit and market risks associated with an acquisition transaction.

2. Negotiating terms of finance documents

The borrower and the lender then negotiate the funding, security, guarantee and covenant requirements and agree to these in the term sheet. As credit and market risks are likely to have an impact on the lender’s decision to fund and on its security requirements, additional conditions may now be applied to address the increased funding risk. Pricing may also be impacted.

3. Lender conducts due diligence on acquisition documents

The lender and its legal advisers conduct due diligence on the acquisition documents and may require tripartite deeds to be prepared to give the lender certain rights with respect to those documents. Social distancing restrictions may make it more difficult for the lenders and their advisers to conduct this due diligence and may require alternative approaches to site visits to review these materials, or may require the bidder and purchaser to attend their offices to collate the necessary documentation for upload to a virtual data room.

4. Drafting finance documents

The lender and its legal advisers draft the finance documents and negotiate these with the obligors and their legal advisers. It is very likely that defined terms such as Material Adverse Effect and events of default that are triggered by a material adverse change in a party or market will be highly negotiated. There may be a push to expressly address how natural disasters, pandemics and other external events may (or may not) trigger a default. Whether such terms favour the borrower or the lender will depend, as always, on the negotiating powers of the respective parties.

5. Preparing a closing checklist and addressing outstanding items

The legal advisers to the lender prepare and issue a closing (or completion) checklist. The parties then work to resolve the outstanding items. Given social distancing requirements and the current remote working arrangements widely adopted, closing the outstanding conditions precedent will likely take much more time and parties should adjust their completion timetables accordingly. Additional pressure on the physical ability for parties to sign the finance documents will also play a significant role in the closing process.

6. Date of drawdown and completion of the acquisition

Once the conditions precedent to the funding are satisfied, a lender is typically committed to providing the finance. However, as there are always several conditions precedent to the funding that can only be settled on the day on which the acquisition completes, there is still a risk that the lender will not be required to proceed. One common condition is tied to there being no event of default, and if an event of default is linked to market conditions, this could be a significant risk for the borrower in times of market volatility.

7. Conditions subsequent – financial assistance whitewash and accession of target company

Typically, the entities acquired in the acquisition transaction are required to accede to the financing documents and provide security and guarantees in favour of the lender within a certain number of days of the funding date. Additional time may be required in times of crisis to overcome the difficulties of arranging the board and shareholder meetings necessary to approve such transactions and to complete any whitewash that may be needed to address financial assistance issues.

For an overview of acquisition financing arrangements and the issues involved for lenders, refer to Practical Law’s Practice note: overview, Acquisition Finance, or follow a timeline of the stages of a standard acquisition funding arrangement (and see the resources available on the Practical Law website for each stage) in our Checklist: Acquisition funding deal workflow resource. A full suite of acquisition finance resources is available to subscribers of Practical Law Australia’s Banking and Finance practice area on the Practical Law website. For more information on Practical Law’s suite of acquisition financing documents and practice notes, register your interest in a complimentary trial.

Justin writes for Practical Law’s Banking and Finance practice area. He joined Practical Law after 13 years in practice at Clayton Utz, Herbert Smith Freehills and Dentons Australia, where he advised on real estate financing, aged care and retirement village development funding solutions, and corporate financing transactions. Justin has acted for all major Australian financial institutions and a range of corporate clients on both domestic and international financing transactions.

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