The impact of the covid-19 pandemic on the global economy is completely without precedent. News that the UK’s economy contracted by more than a fifth in the month of April highlights just how extraordinary the current situation is. Previously, the largest monthly drop had been 2 percent.
Generally, commentators and market participants are in agreement that the immediate future holds much uncertainty. Countries that have started to open back up are navigating their way around ‘the new normal’, with the threat of a second wave and subsequent lockdown hanging over them.
The immediate realities to deal making will be limited availability of acquisition financings (partially due to a majority of corporates drawing down on available revolving facilities) and more lender-friendly terms for any new debt, such as increased borrowing costs and stricter financial covenants. There is likely to be continued uncertainty around market stability and growth over the next six to 12 months.
Acquirers wishing to pursue new opportunities could consider a club deal as an alternative to debt financing. This could enable them to pursue larger targets, stretch their available dry powder, and spread risk across a wider number of investments. In the current market, club deals could be more attractive to sellers. Without the requirement for debt, there is more certainty around a fully equity funded transaction.
A club deal is not without its complications, but these can be managed if the right opportunity exists for the right parties.
From the outset it will be necessary to ensure that the confidentiality agreement permits information to be shared with other equity investors. A seller may be reluctant to allow dissemination of information to potential bidders it cannot control. However, in the current market it is likely that the prospect of having a fully cash funded bidder in the mix, will go some way to allay these fears.
The primary downside that any party entering into a club deal needs to consider is the lack of control when compared to a usual leveraged buyout of 100 percent of a business. A club deal should be considered akin to a joint venture and both parties should not undertake such a proposition without a considerable level of trust and mutual alignment for the immediate business needs, future business plan and eventual exit timeline and strategy.
There will be a further myriad of matters on which the club participants will need to agree. In order to avoid any last-minute complications, it may be best to at least agree the term sheet for such arrangements before submitting final bids and to manage expectations on both sides from the outset. Parties will need to consider the decision-making process for the target entity, the split of board seats and board control, veto matters for shareholders, business plan, future funding commitments, deadlock resolution and drag and tag rights on exit.
As a result of the current economic uncertainty it would likely be prudent to pay particular attention to agreeing the parameters for any future funding requirements, including acquisition financing for any bolt-on acquisitions and also any emergency funding needed to secure the finances of the business should it run into trouble. The more clarity the parties can have on this, the less room for disagreement later when opportunities arise or problems need to be solved in equally short order.
A dispute relating to such a club deal should be avoided at all costs as the only guaranteed outcome of such a scenario will be loss of value to all parties concerned. A clearly defined dispute resolution procedure with a quick, simple and effective route to exit in the event of non-agreement will be important.
There may be other advantages to a club deal involving two or more investors. Different parties may have different expertise, knowledge and specialisms to bring to bear on the target group as well as access to different markets and jurisdictions. It is important that each party’s existing exposures to the relevant sector and markets is understood. This way, it is easier to manage antitrust and other filings and obstacles to the transaction.
Considering the difficulties perceived in the debt markets for the remainder of 2020 and the uncertainty around the route back from covid-19 prior to a vaccine being found, it seems likely that club deals are certainly a viable alternative for those who wish to pursue acquisition opportunities. Such transactions are not without their difficulties, but with two well-aligned and mutually trusting parties, and some good groundwork and early consideration of the potential issues, such risks can be mitigated and certain benefits realised.
James West is a partner in the private equity practice of law firm Mayer Brown’s London office. He advises on a wide range of matters including venture and development capital, mid-market buyouts, corporate M&A as well as working with both investors and management teams on buy-and-build strategies.