Partner Piece – Sales and Brexit: protecting against uncertainty, in uncertain times
November 10, 2016
When it comes to Brexit, it seems that all we know is that…we don’t know. When will Article 50 be triggered? When will the UK complete the departure process? At what point between those two events will various aspects of the EU withdraw from the UK? What effects will it have on the wider economy at each step? We don’t know.
An environment where so many of the big questions remain unanswered can be a difficult one in which to complete the sale of a company. On any given day there is the risk that even vaguely Brexit-related news, and the accompanying market reaction, could put a Buyer off a deal that previously looked attractive.
The intention of this article isn’t to speculate about how Brexit will go, or to advise on the best places to locate a Buyer given the sterling exchange rate. Instead I want to look at some practical issues around the legal process of selling a business, and what Sellers can do to reduce the deal issues associated with Brexit uncertainties.
Do your due diligence
If every day carries with it some amount of risk of a new Brexit development, one way to reduce the risk of something coming up is to keep your process as short as possible. An aspect of a sale that often takes undue time is due diligence, and in particular assembling responses to Buyer’s questions.
Sellers should prepare a good data room, which addresses the major areas that Buyer will seek to explore, at latest by the time the termsheet has been signed; Sellers can anticipate this coming, and speed the eventual process. Professional advisers can help, and are doing their own homework to develop cost-effective ways of doing so. Inevitably there will be follow-up enquiries during the process, but if the Buyer feels comfortable that disclosure is being properly handled then the timetable will be considerably shorter and the risk reduced.
By the same token, full responses to further diligence enquiries will conclude this exercise far quicker than making selective responses and inviting further enquiry. This is not cut and dried, disclosure will continue to be a balancing act for Sellers trying not to frighten Buyer away with too much bad news at once, but in times of market uncertainty there is a thumb on the “disclose” side of the scales.
Push the process
A perennial discussion around sale processes is how much time to spend on the termsheet, and when to move on to the definitive documents. There will always be a commercial driver to have clarity and certainty around the terms of the transaction, but Buyer’s mental and moral (if not legal) commitment to a transaction almost always increases once the termsheet is signed. Leaving detail points for the definitive documents, in an uncertain market, has much to recommend it.
Likewise, once definitive documents are in play, there is real value in ensuring that the Seller has established a deal team, and that the members know their responsibilities and have cleared sufficient time in their schedules. Reviews of the transaction documents, negotiation meetings, obtaining relevant information for disclosures – spreading those responsibilities around a team is essential to avoid bottlenecks and mitigate the risk that some new development derails the deal. The disruption to the deal team’s day-to-day roles in the business is a price worth paying.
The gap and the MAC
A further question is whether a sale could be set up with a period of time between signing and completion, or if it should sign and complete simultaneously. A gap is only usually required for third party reasons (for example because a regulator or merger control authority needs to agree to the transaction), but the advantage of a gap is that Buyer signs the SPA, and is therefore committed to buying the business, without having to resolve every ancillary issue (e.g. new employment contracts for senior staff) and bear the risk of delays on those points. Buyer’s protection during that committed period is a material adverse change clause, or MAC. The intention of the MAC is to give Buyer the ability to walk away if something happens that causes a material downturn in the business or prospects of the target company.
Using Brexit to trigger a MAC, however, may be difficult to achieve. Contract clauses are commonly interpreted against the person using them, and so it must be clear that the event falls within the intention of the clause for Buyer to pull out of the deal. Last year the High Court also suggested that it will consider the impact on the market more widely; in that case they ruled that revision of profit forecasts did not count trigger a MAC clause, and one reason given was that to allow it would produce uncertainty in the M&A market (by introducing a potential new category of MAC-triggering events).
If there is a particular risk that is material to the target company, such as the withdrawal of a particular EU programme from the UK or a major exposure to currency fluctuations, there might therefore be a risk of a MAC being triggered. Absent that specific risk, however, Brexit announcements or events would be unlikely to give Buyer the right to walk away – Buyer will have to clear some high hurdles of interpretation to show that those events are clearly within the intention of the clause and constitute a material downturn in the target’s business or prospects.
Reduce your currency risk
Another way to reduce transactional Brexit risk is consideration structure. Deal terms often push some elements of consideration into the future, payable either on specific milestones or on the business’s performance over an “earn-out” period. This is often attractive to Sellers who believe the business has greater potential, and therefore are willing to accept some later consideration relating to the business’s performance, but given the uncertainty around macroeconomic conditions over the next few years Sellers may want to push harder on initial consideration and less in the earn-out.
It’s also worth thinking about exposure to significant currency fluctuations that seem to follow every remotely Brexit-related move. On a sale to a foreign Buyer, Seller’s exposure is obvious – and simply solved by a contractually-fixed currency exchange rate; but similar thinking can be applied in less obvious areas. If a business reports in pounds but it has substantial sales or cost of sales in another currency, for example, it can be specified in the SPA that the accounts used to calculate any earn-out payment will be adjusted to use one or more stipulated exchange rates.
Conclusions
Uncertainty always creates difficulties for sale transactions, and Brexit in that respect at least is no exception. A prepared Seller can, however, take some simple and practical steps to mitigate uncertainty – this is by no means an exhaustive list. We would, of course, be delighted to discuss further ideas with you if you’re considering a sale process; please do get in touch.
Written by David Willbe, Partner Lewis Silkin LLP
