25 Sep 2019
Brexit Part 3: Corporate Finance: To Acquire or not to Acquire?
There may have been a drop off in the number of completed deals being reported in recent months, probably due to Brexit uncertainty, but for those still prepared to be willing sellers and willing buyers, there will be issues that may need to be covered off with Brexit still in the balance.
There is no question that uncertainty of any kind affects business activity. It is more difficult (or impossible) to plan, make informed investment decisions, in assets or human capital, or just forecast any further ahead than a few months (or indeed past 31 October).
For those considering buying or selling a business therefore, the key issue will be on the one hand to cover off as much as possible how Brexit will affect the potential target that they are looking to acquire, and on the other hand for those selling, to making sure as far as possible that they have hedged what they consider to be the Brexit related risks.
What are those risks? That is an excellent question and with the current Brexit impasse showing no signs of lifting, I will do my best to outline them as I see them here.
Financial and economic
I have mentioned uncertainty above and this will clearly affect the number of buyers wishing to make an acquisition until the wider economy has settled down.
Investments in acquisitions may be deferred due to this uncertainty, amid concerns over a short term economic contraction potentially squeezing liquidity, and access to finance. Buyers funding acquisitions using debt, should be prompted to rigorously review the terms prior to signing, to assess the effect of any “exceptional circumstances” or material "adverse change” conditions in their debt terms, so they know what to expect from their lenders should such a contraction and liquidity shortage arise.
In addition, currency volatility could also impact profitability and even the viability of certain contracts, which may cast doubt on the wisdom of making particular acquisitions, in the short term.
Conversely, for those deals that were put “on ice” until the economic uncertainty arising from Brexit has cleared; sellers may find an expansion in the number of buyers in the market, where a wave of investment is released as more certainty returns to the market.
There is well publicised commentary about the migration cap, and the impact that it may have on the mobility of skilled workers from overseas that I don’t propose repeating here, but for a buyer, making a new acquisition in the UK where there is already a significant labour and skills shortage, ensuring that EU workers already working in the target business, stay, and continue to work in it, will be key to the success of that acquisition.
There has been some comfort provided by the UK government stating that EU nationals settled in the UK on exit day, can apply for settled status, meaning they can continue to live and work here as long as they don’t exit the UK for longer than 2 years.
That said, any due diligence performed around employees of a target business should consider the likelihood of a human capital flight around exit day, as the inability of an employer to retain or replace staff will damage the success of the acquisition.
Supply chains and suppliers
Many businesses, even those who do not expect to be affected by Brexit, are more than likely to find that somewhere in their supply chain is a component, product or service delivered from the EU. There is no question that existing supply chains will be disrupted to a greater or lesser extent.
This may manifest itself in additional cost (administrative, regulatory, or tariff) or extended timings (perhaps not even in the direct supply to the business, but elsewhere in the supply chain) or indeed in the need to establish a new supply chain which will take time to mature.
In the extreme, businesses exposed to Brexit risks that have not taken mitigating measures will be put under greater commercial pressure, potentially affecting customer demand and supply chains.
These factors must be given due consideration by any buyer, and of course should have already been considered and, as far as possible, mitigated by any seller. The difficulty for both parties to any deal is assessing the importance of those risks, where the shape of any “Brexit agreement” is unknown and the visibility of these risks in what may be an extended supply chain is difficult to ascertain.
Any business exporting to the EU, currently only has limited visibility of the access that they will be granted to EU markets after the UK exits the EU, as this will depend completely on the shape of the deal struck (or not) with the EU for exit day onwards.
For buyers and sellers of businesses this is a particularly difficult area, as any divergence between the UK and EU on exit day that may limit access to markets, perhaps because of regulatory reasons, is impossible to gauge without any real idea of what any exit deal will look like.
It is glib to say that planning will help, as we are not yet sure what we are planning for, but businesses must avail themselves of all the official and government guidance available and do the best they can to adhere to that guidance, to try and ensure they are in the best shape possible to continue to access EU markets on exit day and beyond.
Legal and Tax
Much as EU law does not impinge much on English contract law, so Brexit should not affect the operation and enforceability of contracts governed by English law, the terms of contracts may be inadvertently breached by the wider implications of Brexit.
At the extreme, certain contracts may be put in dispute or renegotiated where there is additional cost involved, or a material change required to meet new regulatory provisions, and this would impact a potential buyer of the business where that contract is integral to the deal being discussed.
It may be difficult for businesses with contracts with specific delivery or completion dates to meet these dates because of increased border checks and, therefore, it is worth reviewing all the terms of contracts to assess whether an element of flexibility should be built in to accommodate the potential for delay. Again, the last thing either buyer or seller want is a significant contract being withdrawn because delivery times prove difficult to meet, without the issue at least being raised with the customer.
There may be requirements in the future for contracts to incorporate “change of law” provisions to guard against changes to the wider legal framework, that may materially affect the viability of that contract, and this must be considered by buyer and seller alike.
Cross border corporation taxes and VAT are always complex areas, and those businesses that are currently taking advantage of certain EU-wide tax structuring or single market type exemptions from certain taxes, must be aware of the need to potentially re-align their business to comply with any new cross border direct and indirect tax changes. This could inhibit flexibility and increase costs, so should be considered by all parties to a potential deal.
For buyers, acquiring a business always carries inherent risks and for sellers, particularly where a proportion of the purchase price is deferred and paid over a period following the sale, there are also risks. Does Brexit heighten those risks, for both parties? Certainly it does, although the buyer is probably more at risk, depending on the terms of the deal to acquire the business, as there are so many areas of uncertainty.
That said, with the right legal, accounting and tax advice, those risks can be mitigated as far as possible and of course, the final arbiter of whether a deal should be done or not comes down to price and value; i.e. can both buyer and seller see that they are getting a good deal after considering these Brexit risks.