Accelerated Mergers and Acquisitions (“M&A”)
Accelerated M&A, also known as accelerated mergers and acquisitions, commonly refers to a strategic approach where companies expedite the sale of assets, shares or businesses often due to financial and economic distress.
A company that is not subject to the imminent threat of insolvency may have sufficient cash resource to put itself up for sale. This could represent an opportune moment for potential buyers. It’s a time when the company’s key staff, clients, and suppliers are still in their roles and offering support. This is crucial because as the window of opportunity narrows, the company and its reputation may begin to suffer lasting harm, pushing it closer to insolvency. This situation can begin to unfold as information about the sales process or the company’s financial predicament becomes more widely disseminated. This can be especially challenging for publicly traded companies that are obligated to keep the market informed about significant developments impacting the company.
While a lender typically has the option to accelerate the repayment of a loan when the company breaches the terms outlined in the facility agreement, creditors often stand to gain more by endorsing a restructuring of the company’s debts rather than pushing it into a formal insolvency process. It’s common for them to engage in a standstill agreement with the company, which provides valuable time to safeguard the company’s operations and its reputation.
The sales process is therefore often driven by the lenders who may not share the same incentives as the company’s directors or an insolvency practitioner when it comes to maximising the sale price of the assets. Typically, an insolvency practitioner is duty-bound to secure the best possible price for the assets, prioritising the interests of all creditors. In contrast, a lender’s primary concern is to recover the amount owed to it, and they may adopt a more risk-averse approach. Their focus may not necessarily be on obtaining the highest sale price but on ensuring that the proceeds are sufficient to cover the outstanding debt. This misalignment of incentives can make the sales process more intricate, as it requires careful negotiation and coordination among the different stakeholders to reach a mutually acceptable outcome that addresses the interests of all parties involved.
In most sale processes for distressed assets, an auction is commonly employed. However, these auctions may differ from conventional auctions due to tight time constraints involved. The marketing of the distressed assets may be more limited compared to standard processes.
Distressed asset sales are typically marked by several tactics and strategies. One of these strategies is known as “credit-bidding.” A secured lender is allowed to participate in the auction and bid for the assets it has a security interest in, using the debtor’s outstanding debt as a form of payment. This allows the lender to potentially acquire the collateral securing the debt, effectively offsetting the outstanding amounts owed. This can serve as a way for secured lenders to protect their interests and potentially recover some or all of their outstanding loans by acquiring the distressed assets through the process. It is a notable feature of such asset sales, and its utilisation can significantly impact the outcome of the sale and the distribution of proceeds among creditors and stakeholders.
A potential investor in distressed companies should not limit themselves to acquiring the company’s shares. When the value of the debt becomes compromised, an alternative option is to purchase that debt, often at a substantial discount to its nominal value. Many investors employ this “loan-to-own” strategy to secure control of a company. Owning the debt and becoming one of the distressed company’s stakeholders who collaborate closely with its directors provides them with access to information and influence. This combination of factors bestows a considerable strategic advantage in negotiations aimed at acquiring the company’s assets.
Frequently, there is insufficient time for comprehensive due diligence, and access to or the availability of due diligence materials may be limited. Vendor due diligence, which could provide buyers with a head start in the diligence process, is rarely conducted. Consequently, buyers are often faced with the added expense of conducting their own due diligence on the assets. This, combined with a tight schedule, necessitates that buyers and their advisors concentrate their efforts on critical issues and the most significant risks. The buyer’s objectives remain consistent: ensuring that the assets are free from any encumbrances, identifying change of control consents or retention of title clauses in significant contracts, understanding which employees may be automatically transferred by operation of the law, and assessing the risk associated with the potential transfer or attachment of pension liabilities or successor liabilities under environmental law to the assets being acquired. These concerns are fundamental to safeguarding the buyer’s interests, regardless of the distressed nature of the transaction.
Typically, buyers prefer structuring an acquisition as an asset sale because it grants them the flexibility to select the specific assets they want to acquire while leaving behind any liabilities, including those that are unknown or contingent. However, there’s often a conflict of interest between buyers and sellers. Selling shares in a company is usually a faster process, involves simpler documentation, and can offer more favourable tax treatment to the seller. In contrast, in an asset sale, the seller must identify each asset and may need to obtain consents for asset assignments or transfers.
Buyers may opt to acquire assets through a formal insolvency process as a way to reduce the risk of creditors challenging the transaction after it has occurred, especially if the seller is or becomes insolvent. One approach to address this concern is the use of pre-packaged administrations, often referred to as “pre-packs.” In a pre-pack, the transaction is negotiated with an insolvency practitioner who is poised to step in pending a formal appointment. This insolvency practitioner then promptly signs the sale agreement immediately after or shortly after formal appointment. In addition to mitigating the risk of claw-back by creditors, this process offers the advantages of speed and typically ensures the continuation of the business as a going concern. In the case of a pre-pack, this entails the administrator adhering to Statement of Insolvency Practice 16, which imposes obligations on the administrator to make disclosures to creditors. These disclosures may include reasons for choosing the pre-pack route and the steps taken to determine the purchase price. Furthermore, in structuring any sale process, sellers generally seek maximum deal certainty. This is especially critical in a distressed situation, as the impending insolvency often necessitates a rapid process with limited or no room for a buyer to withdraw after a deal has been agreed upon. This need for certainty applies to various aspects of the deal documentation. Ensuring that the business has access to funding throughout the pre-closing period is also crucial, and buyers may be required to provide interim funding in such cases.
Buyers typically do not receive warranties from sellers. Furthermore, if the company is undergoing a formal insolvency process, administrators do not provide warranties either. Even when warranties can be secured, there is often uncertainty about whether the seller can fulfil those assurances in the event of a claim. Engaging with the management, provided they maintain the trust of existing stakeholders, can aid buyers in obtaining more due diligence materials and a deeper comprehension of the business. Historically, underwriters have been hesitant to provide warranty insurance coverage, in cases where the customary due diligence and disclosure process were absent. However the buyer can directly engage with an insurer, where no warranties are provided by the seller or administrator. This approach can be appealing to sellers and/or administrators, as it shifts the responsibility to the buyer and eliminates their involvement. Nevertheless, these policies come at a cost and are typically more expensive than traditional warranty coverage.
It is important to remember that sellers often include an “anti-embarrassment” clause in the sale documentation. This clause stipulates that the buyer must make an additional payment for the sale assets under specific trigger events, typically occurring within one to three years after the distressed sale. These clauses are especially prevalent in cases where there has been a pre-pack sale by an administrator, where the business underwent a relatively limited marketing effort, or where the acquisition of the business or assets took place following a restructuring, resulting in certain creditors accepting less than the full value of their debt. Typically, when a business is sold in a distressed state, it is sold at a discount compared to its “market value,” reflecting the distressed nature of the sale and the absence of contractual protections for the buyer. The inclusion of an anti-embarrassment clause allows the seller to participate in some of the potential upside that the buyer might enjoy if they were to resell the business shortly after the initial sale. It’s important to note that the purpose of such a clause is not to prevent the buyer from benefiting from improving the acquired business. Given the challenges in determining the valuation and pricing of risks, there may be flexibility to negotiate a lower initial purchase price with an enhanced anti-embarrassment payment or an extended period during which the clause remains applicable.
Acquiring assets, or even taking control or ownership by enforcing security in the event of a default, could potentially serve as a triggering event for the authorities. The National Security and Investment Act 2021 came into force on 4 January 2022 and has a wide-ranging impact for transactions in certain sectors. The Act permits the UK Government to scrutinise and, where appropriate, intervene in proposed acquisitions that may harm the UK’s national security. Failure to gain clearance for certain transactions may lead to significant sanctions, including turnover-based fines and criminal liability. Additionally, an acquisition will be automatically void if it is determined to be subject to the mandatory notification regime and approval has not been obtained in advance.