Time tends to be the enemy of all deals. Particularly in a merger or acquisition, the longer the process drags on, the greater the likelihood a deal falls apart. And those seeking venture financings are finding the longer the deal takes, the lower the valuations and investor interest. So, in the era of COVID-19 when the unexpected has become common, time is even more precarious. Tech startups looking to mergers or acquisitions as their exit strategy should recognize that the clock is ticking and prepare accordingly to ensure the fairway to signing is as clear as possible.
Here a few best practices to help make sure an M&A transaction gets done.
- Ensure that the letter of intent has a limited exclusivity provision to help drive a steady timeline for due diligence and negotiation of the agreements. Although the exclusivity period can later be extended by the parties, applying pressure at the onset can help push a buyer to sign.
- While communication is vital to any business or transaction, clear communication in cross-border M&A during a global pandemic when the parties cannot meet face to face can be the difference between a deal signing and the parties going their separate ways. Tech startups should avail themselves of video technology to create transparency and alignment of goals with the buyer. Ensure that the deal data room is complete and conforms to the buyer’s specifications.
Be as detailed as reasonably possible as to what has not been done in the ordinary course as a result of COVID-19. Ordinary course is a term frequently negotiated in M&A agreements, but in the era of COVID-19, the term has led to greater negotiation between parties. For example, do reps and warranties or covenants reference back to business pre-global pandemic or do they take into account the new norm? Have a clear list of what has changed for a tech startup, whether it be as significant as a loss of revenue to as mundane as a new software application to better assist remote workers connect to meetings. Doing so will enable the startup to respond to buyer inquiries and to bargain for better deal terms.
- Revisit as early as possible existing commercial agreements to determine whether a tech startup can fulfill existing contractual obligations in light of COVID-19. In particular, assess the “force majeure” clauses and determine whether there is any reprieve for either party in fulfilling its obligations. The interpretation of force majeure provisions depends on jurisdiction and country, so parties will want to ensure they understand the applicable rules and available remedies in the relevant jurisdictions and countries particularly when negotiating with a non-U.S. buyer in cross-border M&A.
With respect to venture financings in the current COVID-19 market, companies without a path to revenue in the next year are confronting reduced valuations and investor interest.
Here are several of the key action items for start-ups in this category.
- Coordinate a bridge financing round with existing investors by consulting with investors as early in the process as possible.
- Consider offering warrant coverage and liquidation premiums as an incentive for existing investors, and initiate discussions with investors as early in the process as possible since lead times to closing will be extended given the virtual deal environment.
- Given current market conditions, communicating the value proposition and business progress to investors and other stakeholders is even more important than normal.
- Consider valuation adjustment mechanisms tied to milestones and performance objectives to allow for upward or downward adjustments as a means to bridge valuation gaps in discussions with prospective investors.
- Review compensation terms and headcount and evaluate adjustments within the context of labor and employment law requirements.
- Prepare for virtual due diligence and develop strategies to present company data and documents on a real-time basis through virtual document rooms. Invest in available robust data room products.
- Streamline financing document terms with an eye towards limiting investor concerns as a gating item since closing on a timely basis will be the priority.
- Consider alternative sources of funding including non-recurring engineering (NRE) and other custom development work.
With the degree of uncertainty in the markets, these steps will help prepare all stakeholders involved for the various scenarios in a financing or M&A exit.
Morgan, Lewis & Bockius LLP partner Karen A. Abesamis focuses her practice on M&A, strategic and venture capital investments, and technology transactions. She can be reached at [email protected] Partner John Park focuses his practice on debt and equity offerings, public securities offerings, recapitalizations, and M&A. He can be reached at [email protected]