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How will M&A buyers respond to Covid-19?

03 April 2020

Earn-out deals

Coronavirus has already caused widespread economic carnage in the UK and the fall-out is likely to raise serious problems for buyers who have recently acquired a business and for those still actively considering acquisition opportunities.

One of the most immediate problems a buyer is likely to face is if it has recently entered into an “earn-out” deal – an acquisition where part of the purchase price is deferred and paid out over a set period of time after completion.

In “normal” times these deals can work well for buyers. Paying sellers over three or four years allows them to prudently reflect the true value of the goodwill in the price paid and, in the process, retain and incentivise key seller-managers and smooth integration.

However, a buyer which is party to a deal including an earn-out period which ended on 31 December 2019 may now be facing the prospect of a significant cash payment falling due which it cannot meet as result of its own reduced cash flow.

Varying a cash-based earn-out

Generally speaking, any variation to the terms of a share purchase agreement will require all parties to agree to it and for the variation to be recorded in writing. So, any attempt by a buyer to unilaterally try and impose new terms on a seller is likely to constitute a breach of contract.

However, most sellers will be acutely aware of the current issues and so seeking to negotiate a formal extension of time to pay is the first option to consider. Sellers whose final earn-out period ended on 31 December 2019 and who not planning on staying with the business may take a harder line. But those who are part-way through a deal may be sympathetic.

Although their business may well have performed well in 2019, any earn-out which takes account of any part of 2020 will be hit hard. Sellers in this position may therefore be prepared to agree to a request for an extension of time to make an earn-out payment in respect of 2019, provided the buyer agrees to vary the earn-out calculation in respect of 2020, so as to mitigate the effect of coronavirus on the value of business they have sold.

Any buyer contemplating varying an earn-out should take professional advice though. Earn-outs are complex from a tax perspective and certain variations may risk the deal being recharacterized as a “bonus” scheme by HMRC, and therefore subject to income as opposed to capital gains tax, with resulting PAYE and National Insurance Contributions liabilities arising in the acquiring company.

Alternatives to cash

In an economic climate where a buyer may need to conserve its cash reserves this year or for which a cash payment is not a viable option, it may wish to consider offering alternative forms of consideration, such as issuing shares or loan notes. A buyer could do this both where it needs to vary the terms of an existing cash-based earn-out and also for any new deals it may be contemplating.

The commercial viability of offering shares as consideration will of course depend on the impact the coronavirus has had on the value of the shares being offered. It is also more common for a buyer to issue shares as consideration where its shares (or the shares of the entity in its group being offered) are publicly traded, as such shares are readily marketable (and therefore more likely to be acceptable to sellers as an alternative to cash).

However, private companies can also pay some or all of the purchase price in shares and, in both cases, doing so may incentivise owner-managers to remain with the target company following completion, by aligning their economic reward with the performance of the buyer.

Offering shares can lead to additional complexity though, particularly for private company buyers. If sellers are willing to accept shares in a private company and will be in a minority position, they are likely to seek certain key protections (such anti-dilution protection and some “veto rights” or “reserved matters” in respect of key decisions).

This may require new articles of association and a new shareholders’ agreement (or amendments to existing documents) and so the buyer will need to take proper advice to ensure it retains a suitable degree of overall control, relative to the percentage holding offered to the sellers. 

Another alternative to cash is a buyer loan note. Loan notes are flexible and can be issued for a specific amount at a fixed interest rate, so as to provide a guaranteed economic return. For private companies, they may also be more acceptable to sellers than shares, as they are not subject to the same liquidity issues given they usually provide for redemption (i.e. repayment) on a particular date.

As with issuing shares there will be a range of issues to consider, such as whether the loan notes should be freely transferable and whether the sellers will require any particular protection (they may, for example, require a right of veto as regards the priority of payments as between the loan notes and any other buyer loan facilities). But, generally speaking, they may be simpler to deal with than issuing shares.

Future protection

It is not possible to try and provide for every conceivable eventuality in legal documents. But given the unprecedented economic impact of coronavirus, buyers may wish to consider whether they can include any additional, practical, protection in their deal documents.

Although not currently widely used on English-transactions, a material adverse change or “MAC” clause provides some protection where a transaction involves a split exchange and completion. Typically drafted as a condition to completion, a MAC clause provides a buyer with a right to withdraw in the event anything happens which has affected (or which may affect) the value of business being acquired.

This type of MAC clause may provide some useful protection. But many buyers will also be concerned about how to deal with another pandemic (perhaps a second wave of coronavirus) impacting deals with deferred payment structures where the MAC event occurs during the earn-out or deferred payment period.

It may be possible to extend the concept of a MAC clause further and provide a buyer with an option to further defer a payment which would otherwise due in the event that a MAC event has occurred and/or is continuing.

This would be a significant, further, re-allocation of risk from the buyer to the sellers and so likely to be heavily resisted. But it may be an option where a buyer is in a particularly strong negotiating position.


If you would like to discuss any of the issues raised in this article, then please contact any of the authors or your usual Lewis Silkin contact.


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