Proactivity and creativity in mergers and acquisitions during COVID-19: 5 key issues

Written in collaboration with Rios-Karim Mercier, partner at Cafa Corporate Finance


Mergers and acquisitions were particularly active in Canada until the government response to COVID-19 disrupted transactional practices and led to a slowdown. Parties involved in M&A transactions must keep a watchful eye on the situation and be proactive about managing the accompanying risks at every stage in the process. In the current context, prudent risk management will primarily involve negotiating or renegotiating a deal’s terms and conditions, some of which are discussed in this article. 

The professionals at Langlois Lawyers and the experts at Cafa Corporate Finance highlight 5 practical considerations and creative suggestions related to COVID-19: 

1. Working capital adjustments

Usually, the purchase price is expected to be adjusted following the closing of a transaction, based on parameters established in advance by the parties to a purchase agreement. One of these parameters is the business’ working capital (current assets minus current liabilities) delivered at closing. A working capital target is usually established based on historical financial data. The difference between actual working capital at closing and the working capital target will generally result in an upward or downward adjustment to the purchase price. 

However, the current situation has had a significant impact on companies’ liquidity and working capital. This can lead to a number of problems, including the following: 

  • Revenue: an unavoidable drop in sales may reduce working capital (less accounts receivable and inventory) and could justify normalizing the calculation of the working capital target to exclude the COVID-19 period; 
  • Salaries and deductions: many companies are relying on government emergency programs to cover salary payments, which could entail some retroactive adjustments or more stringent verification; 
  • Accounts payable: some companies may have “stretched” payments to suppliers in order to retain cash; this should prompt buyers to check (i) the status of relationships with important suppliers and (ii) that the level of accounts payable is consistent with historical levels. 

Parties should pay close attention to the clause detailing a purchase price adjustment based on the working capital target at closing, in order to avoid unpleasant surprises once this calculation has been made. Moreover, buyers may want to negotiate and retain a larger amount in escrow to cover post-closing adjustments to address working capital shortcomings, which seem more likely in the current circumstances.

2. Due diligence

We are currently seeing more thorough and complete due diligence as the preferred approach by many buyers wishing to participate in M&A transactions. We support this position and suggest targeting the following aspects, which we have identified as riskier in the current context, without of course engaging in costly and useless audits. 

On the legal front, we recommend closer scrutiny of the working conditions of the target business’ employees in the context of COVID-19. For instance, if a business is considered an “essential service” and operates in the manufacturing sector, it will be important to check whether the employer has implemented appropriate health measures to reasonably prevent infection of employees. Other businesses may have had to lay off employees. Buyers should analyze the terms and conditions of these layoffs in order to assess the risk of recourse against the target. Another area for comprehensive review is the business’ contracts, especially if they contain “force majeure” clauses. Buyers need to know if commercial contracts representing significant revenue can be terminated in case of force majeure, or whether payments, such as commercial lease payments, can be deferred. Buyers should also check any credit agreements or other commitments to lenders that will remain in effect after the transaction closes, particularly to assess the risk of default by the target. 

On the balance sheet, special attention should be paid to liabilities, including: 

  • Emergency loans: all loans, including those received in connection with the COVID-19 programs offered by the Business Development Bank of Canada (BDC), Investissement Québec (IQ) and others; 
  • Salaries: liabilities for employee salaries, particularly if temporary layoffs occurred; 
  • Lease payments: lease liabilities, given that many companies have negotiated exceptional payment terms (note that interim statements generally do not list contingent liabilities). 

On the income statement, special attention should be given to items affecting cash flow, including: 

  • Revenue: verify that all customers whose business has a significant impact on the target business will be able to survive the crisis and remain customers; 
  • Raw materials: some suppliers could stop or significantly slow down production, which could temporarily increase the cost of raw materials or even jeopardize supply if operations cease indefinitely; 
  • Salaries: check whether salaries will return to pre-COVID-19 levels or if some layoffs will become more permanent; it will also be necessary to net out the impact of any payroll subsidies received. 

3. Valuation

The valuation of a business based on interim results will likely be affected to a considerable extent. There are a few options to normalize the situation: 

  • Normalization of EBITDA: consideration may be given to normalizing EBITDA for the COVID-19 months, for instance, by replacing them with an average from previous years; this, of course, requires confidence that activities will return to historical normality when the situation is restored (see next point regarding contingent consideration); 
  • Contingent consideration (earn-out): a contingent consideration clause may be used so that a portion of the purchase price becomes payable only if the business meets certain performance thresholds following the transaction close. This will have the effect of deferring the payment of a portion of the purchase price and making it dependent on future financial results, preferably when the business has returned to a normal level of activity. If this mechanism is provided for in the purchase contract, the parties could consider setting a target to be achieved based on the business’ historical levels and allowing the financial references for the earn-out calculation to be “normalized” based on past performance. Thus, if the business returns to its pre-crisis level, the seller will obtain the desired valuation. The parties will need to determine at which point, after the close of the transaction, the business’ financial data will be used to calculate the contingent consideration. That point need not be a specific date; it is sufficient that it be determinable and that the parties be certain that the event being used for this determination will, in fact, occur. For a conditional consideration clause to be effective, both the buyer and seller must demonstrate creativity and good faith in seeking a compromise that satisfies both parties. 

4. Two-step transactions

The pandemic will likely increase the number of two-step transactions. These transactions consist of signing an initial purchase and sale agreement, with the closing of the transaction being subject to certain conditions. This approach allows the parties to formalize the terms and conditions of the deal in a binding agreement, while also granting a waiting period before closing, which will make it easier to determine the effects of the pandemic on the target business. 

With two-step transactions, it is important to both sellers and buyers that there be well-established parameters for the interim period, i.e. the period between the signing of the transaction and its taking effect. For example, there needs to be sufficient flexibility to obtain consents from third parties (e.g. financial institutions, landlords and authorities), which may take longer than usual. Likewise, in conducting their day-to-day business, sellers will want to retain more flexibility than is typically granted during such interim periods, as they must react quickly to unforeseen situations arising due to the pandemic and the government responses to it. 

Another approach could be to negotiate a deferred consideration arrangement (such as a break fee). In this case, sellers should consider requiring compensation in the form of a non-refundable fee to cover their direct and opportunity costs if the transaction does not take place. 

5. Use of a material adverse change clause

In the case of a two-step transaction, the negotiation of a material adverse change clause is of considerable importance in the current context. Properly negotiated, this clause will allow for the risk stemming from the COVID-19 situation to be efficiently allocated between buyer and seller. 

Usually, one of the closing conditions for the benefit of the buyer is the absence of a material adverse change between the signing of the purchase and sale contract and the closing. In such a case, the vendor would likely want the agreement to clearly state that the COVID-19 situation cannot be used to claim that one of the closing conditions was not met. Instead, the parties should negotiate parameters that are much clearer and more precise, in order to transfer the risk associated with the pandemic in accordance with their respective wishes. 


There will undoubtedly be other considerations specific to each transaction. Moreover, the current slowdown or hiatus in business activity will give companies time to prepare for the resumption of M&A activity once government restrictions related to the pandemic are lifted. There may be an opportunity for businesses to take advantage of this period to identify potential buyers or sellers and, in the case of the sale of a business, to prepare for the necessary due diligence. 

Do not hesitate to contact the members of Langlois Lawyers’ Mergers and Acquisitions team and the Cafa Corporate Finance team to find out where to start and to get the assistance you need in this process.

Up arrow Top of the page