Weighing the Risks of a Technology M&A Transaction During the Pandemic

September 17, 2020

Technology companies and startups have historically thrived off M&A transactions, but the pandemic has added a new layer of uncertainty to an already complex process. Businesses in the software and technology industries right now are facing pivotal questions, like: Is an M&A transaction still possible? What are the new risks related to COVID-19? How can I protect myself as a buyer or seller?

While uncertainty is unavoidable throughout this pandemic, there are still tools that companies can use to both assess and mitigate risk when considering an M&A transaction. In a recent webinar, Aprio brought together a panel of experts to discuss the topic, reflecting on the impact of COVID-19 on these transactions, as well as how traditional risk mitigation during negotiations has changed.

Panelists included:

  • Howard Zandman, Partner-in-Charge of Litigation Support and Forensic Accounting Services at Aprio
  • Theodore “Teddy” Brown, Director of Litigation Support and Forensic Accounting Services at Aprio
  • Sean Crnkovich, Managing Director of Transactional Risk Practice at Marsh & McLennan Companies
  • Theodore “Ted” Blum, Managing Shareholder at Greenberg Traurig

How have the Effects of COVID-19 Changed the Nature of M&A Transactions?

The effects of COVID-19 on society and business have ranged from obvious to enigmatic, and the impact on M&A transactions has been no exception. As Ted Blum explained, the pandemic mercilessly threw buyers and sellers into a new dynamic for negotiations and allocation of risk during a potential transaction. But in many ways, that new dynamic meant a return to basics. The pandemic has forced both parties to put a new emphasis on identifying, theorizing, and assessing risk, as well as evaluating each party’s willingness to take on that risk for the sake of the deal. Navigating this process in the new COVID business world requires more dialogue than ever to achieve a positive outcome for all.

Is Representations and Warranties Insurance Still an Option?

Before the pandemic, M&A transactions had come to rely heavily on Representations and Warranties Insurance (RWI) as a tool to mitigate risk; it allowed all parties to focus on the deal at hand rather than drowning in theoretical risk. However, the pandemic ignited a new hesitancy for insurers to cover losses and exposures that may be related to COVID-19. In turn, companies began to doubt whether RWI was still a valid and obtainable protection.

Sean Crnkovich explained that, at the start of the pandemic, insurers turned to a more dynamic process when underwriting RWI policies. Policies were previously based on very standard coverages, but now they must embed new flexibility to respond to the effects of COVID-19. Early RWI policies during the pandemic simply included a blanket exclusion of any loss attributable to COVID-19; now, insurers are embracing a broader spectrum of coverages, often signaling to the clients a willingness to negotiate on what is and isn’t attributable to COVID-19.

The coverage available through RWI during the pandemic can also vary by transaction and industry. For instance, an insurer may draw a harder exclusion on COVID-19-related coverage for a company that’s likely to see a dramatic impact. This can be seen as good news for many tech companies, whose businesses may have been less severely impacted than others

What Other Tools are Available to Mitigate Risk for Buyers and Sellers?

RWI isn’t the only tool that buyers and sellers can leverage for protection during an M&A transaction. In fact, some of the impacts of the pandemic have highlighted the importance of other protections, such as thorough due diligence, escrow, earn-out structures, and indemnifications.

While the pandemic may have made the process of performing due diligence more difficult, it also made it more important than ever before. COVID-19 has brought a heightened focus to comprehensive diligence on the part of the buyer and the seller to ensure a smooth transaction with minimal surprises that could threaten the entire deal. The uncertainties of the pandemic mean complications and complexities are more likely, but the appropriate due diligence entails a more thorough understanding of any potential concerns and how the financial model addresses such concerns. Such analysis can lead to more creative solutions that prevent deals from collapsing, such as a change from a flat purchase price to an earn-out structure.

As technology and startup companies consider additional ways to reduce risk in a transaction, due diligence (accounting, tax, legal, IT and other commercial and operational diligence) can be particularly useful and of the highest importance to enhance buyers understanding of the seller Ted Blum emphasized that the most important protection against unexpected COVID-19-related losses is to follow the money: analyze historical revenue, observe how sales have been impacted, and understand changes in customer contracts. The best way to “follow the money” is through due diligence professionals, like those at Aprio.

The Bottom Line

While the pandemic may have made M&A transactions more complicated and perhaps added more inherent risk, it hasn’t made a successful transaction impossible. This is especially true for those technology companies who may have seen a lesser impact from COVID-19 on sales and revenue. For any M&A transaction, and especially one involving RWI, it is important to work with the right team. Finding the right lawyers is key, but skilled accountants and transaction advisors are crucial to the process as well.

Aprio’s Transaction Advisory Services, as well as Aprio’s Litigation Support and Forensic Accounting Services, are here to help. Contact Chris Williamson or Teddy Brown to get started.

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