The global pandemic that so dramatically forced the world economies to shut down, has led to a surprising number of mergers during the last quarter of 2020. This sudden influx of M&A has amounted to more than $1 trillion in transactions in sectors that might benefit from the coronavirus crisis, such as the technology sector. A high-ranking Citigroup executive, Alison Harding-Jones, urged CEOs and boards that “the way out of this crisis is through M&A” and strategic repositioning in a post-COVID era. Goldman Sachs’ head of M&A, Stephan Feldgoise, postulated that corporations are eager to explore this uncharted territory by expanding and diversifying their businesses. The accretive benefits of M&A, however, have often been argued to be circumstantial, while the legal pitfalls could be significant.
The v-shaped increase in M&A activity indicates that managers believe in the benefits of a potential acquisition. However, a study showed that a merger with no apparent synergies, driven mainly by the expansion and diversification cited by Feldgoise, would lead in consumer surplus and loss of revenue for the corporation. As such, a hedging position through M&A on horizontal or unrelated vertical products would not have a desirable effect, unless the goal is to also achieve synergistic value. On the contrary, the managers’ accretive expectation could be justified not only in absolute measures of efficiency or synergies, but also in the effective tax rate, which has been found to decrease on average by 6.7% for the acquirer. This could potentially be a strong liquidity injection for the corporation during tumultuous times. Another view suggests that rational managers might knowingly proceed in an unprofitable merger. Managers could be seeking an event-driven stock price support. As such, the M&A activity indicates that managers employ this move strategically for a variety of reasons and not just accretion or expansion and diversification.
Despite the strategic benefits that M&A pose, lawyers warn that there are legal implications that could render those benefits void. A critical step to correctly identifying a target company without encountering legal pitfalls is an in-depth due diligence process. Especially during a post-COVID era, vetting a target company to assess the transferability of liabilities should take a primary role in the acquirers’ priorities as it could substantially affect the purchase premium. Furthermore, during this time it would be salient to assess the third-party contractual consent requirements as they could act as a deterrent of a potential acquisition. This is also the case for substantial third-party business agreements, where Force Majeure clauses, during the pandemic, could lead to their dissolution and to a substantial loss of revenue for the acquirer. Moreover, in the current fast-changing environment target indemnification provisions and subsequent indemnity caps need to be very tightly drafted, as the indemnitee/acquirer is more likely to utilize these provisions. However, nowadays, the implementation of insurance schemes has substantially mitigated the risk of post-closing M&A indemnity risk.
Another, legal implication that managers need to consider is the stock to cash ratio as a means of acquisition. Acquiring companies through cash is a more straightforward process. Stock acquisitions, on the other hand, provide a portion of control to the target stakeholders, forming new board and stakeholder relationships, which need to be safeguarded for the success of the deal. Another major factor that managers should consider is the tax deferment incentives that stocks offer to target stockholders, as their tax obligations can be deferred unlike cash receivables. During a post-COVID era, acquirers seek to hoard cash as an insurance against uncertainty, leading them to seek stock offering deals. As Mr. Beck, the head of M&A of UBS said, it also means that “there is also a lower premium as target stakeholders will participate in the combined entity.” However, due to the uncertain environment, many factors need to be carefully provisioned such as whether the shares will be of fixed amount or fixed value, leading negotiating parties to follow a stricter approach clawing to their positions.