Conducting financial due diligence in Covid times

Buyers should apply a greater, but tailored due diligence process, which has a knock-on effect on the sale and purchase agreement. PHOTO | SHUTTERSTOCK

By RAVI SHAH
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Summary

• Buyers should ensure that a thorough financial due diligence, Value Creation plan and a well-negotiated and documented sale and purchase agreement is in place to reflect the economic impact of Covid-19. If any of these are missing, the value of a deal could be at risk.

The Covid-19 pandemic has resulted in an economic and medical crisis besides presenting the greatest global challenge since World War II.

For businesses, the effects of the pandemic are far and wide – from disruptions to supply chain and business operations, to trade restrictions and the inability to fulfil contractual obligations. However, with Pfizer and BioNTech, and Moderna announcing successful trials of their vaccines, many companies are now thinking through their recovery and a new reality phase.

So, what does this mean for investors looking to invest in these Covid-19 dominated times and how do they conduct a financial due diligence to aid in negotiating and drafting sales agreements?

In the Covid-19 era, new trends such as deferred spend on capital expenditure, slower inventory turns, extended term payables, long outstanding debtor balances, employee claims, litigations, one-off costs such as restart-up costs, tax deferrals, deferred bonuses, and labour cost impact and productivity, have emerged.

While such trends may be a concern to merger and acquisition activities, it is expected that buyers should apply a greater, but tailored due diligence process, which has a knock-on effect on the sale and purchase agreement.

Except for distressed assets, it is expected that buyers will be walking into a company with adequate assets.

In relation to financial due diligence over this period, companies have tried to isolate the one-time impact of Covid-19 on earnings beforeinterest, tax, depreciation and amortisation (EBITDA). However, such analysis has limited value and relevance in presenting adjusted EBITDA for the year 2020 as this is subjective.

As such, buyers are likely to increase their focus on forward looking financial performance and cash flows, and present cash burn and pre-tax cash flows of companies they seek to invest. They will also focus on ‘Value Creation’ within a deal when looking at price and exit strategies.

Compared to the traditional financial due diligence, there is an emphasis for buyers to focus on the following areas as part of their investment decision processes in the current challenging business environment: