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The current financial environment has created a unique paradigm for the M&A market. There is a confluence of factors at play that affect drivers, risk factors and trade-offs in the space. Understanding these effects and how to manage them is critical to the success of any firm currently active in the M&A space.
Buy-Side Liquidity Strategy
With the markets suppressed, acquirers are assessing their long-term liquidity needs against the backdrop of buy-side opportunities. There are great bargains available for the buy side looking to capitalize on dislocation in the market since many mid-caps are listed, and private companies are perceived to be undervalued and potentially acquired at attractive multiples. The challenge in these uncertain times is to determine whether a long-term strategy for an acquirer will benefit or compromise its liquidity position. Should the acquirer choose to stay liquid in anticipation of protracted distress in the year ahead? Ultimately, the acquirer must determine if the target is a good use of liquidity.
One strategy many firms are taking is to draw down in full on their liquidity facilities to acquire the attractive target. Another strategy that is being considered is identifying creative buy-side financing options when a buyer is asset-rich or the asset being acquired has immediate cash flow value. Buyers may monetize existing cash flow on portfolios to raise funds for acquisitions and similarly may look to leverage cash flow on a target acquisition to secure liquidity either in the commercial bank market or mezzanine debt and nonbank financial markets. Of course, these options add cost to structuring and potentially may include the role of a Collateral Agent and Account Bank services.
Portfolio Asset Capitalization
Equally important in the private equity space is playing defense with portfolio assets. PE firms must ensure their portfolio companies are fortified and appropriately capitalized before considering an acquisition in the fund. Working with the management teams and evaluating access to the credit markets to refinance portfolio companies with weakened balance sheets will be critical to this effort.
CARES Act and Paycheck Protection Program Buy-Side Risks
The CARES Act and Paycheck Protection Program created a new class of M&A risks that also need to be considered, managed and negotiated into an asset purchase agreement. In general, the government programs were deployed swiftly to provide funds to companies that needed them to maintain operations. As such there may be subsequent due diligence needed to ensure those who received program funds were truly qualified and disbursed funds in accordance with the terms of the programs.
From an M&A perspective, this presents several possible contingent liabilities:
- A target company may have applied for and received program funds to which they were not entitled.
- A target company may have applied for and received program funds, and subsequently did not deploy the funds in a manner consistent with the program’s requirements to achieve forgiveness.
- After an acquisition or merger, an acquirer, a target company or a combination of the two may find that they no longer qualify for the program(s).
- The Small Business Administration has reserved the right to audit all loans of more than $2 million within the next five years.
Should funds need to be returned, there is currently little if any precedent for how these matters will be adjudicated or resolved.
The Role of Escrow Services in M&A Risk Management
There are a series of normative acquisition risks that are managed by escrow services related to contingent liabilities. An escrow agent can manage cash flow between the acquirer and the target as it relates to indemnification, earn-outs, royalties, talent retention, contingent liabilities related to litigation, regulatory issues, audits, reconciliations and so on. A neutral third party to hold funds on behalf of the acquirer and the target provides comfort that both parties must agree on the outcome of the funds prior to the escrow account being released.
Escrow and Specialized Services from Texas Capital Bank
When you choose the Escrow and Specialized Services team at Texas Capital Bank, you work with one of our efficient and highly conscientious agents. With experience in virtually every industry and asset stack, we create individualized business solutions tailored to your specific deal needs and help mitigate your risk challenges. Whether you’re conducting business with counterparties across town or across the globe, Texas Capital Bank is proud to perform all escrow agency, depositary and specialized agency duties, across any industry and over any duration.
About Texas Capital Bank
Texas Capital Bank, N.A. is a wholly owned subsidiary of Texas Capital Bancshares, Inc. (NASDAQ®: TCBI) and is recognized as one of Forbes’ Best Banks in America. Texas Capital Bank is a commercial bank that exists to power prosperity in business and in life. We are headquartered in Dallas, Texas, and work with clients across the country. All services are subject to applicable laws and regulations and service terms. For more information, visit www.texascapitalbank.com. Member FDIC.
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views and opinions of Texas Capital Bank, N.A.
This post is part of a series of articles by ACG Boston's Virtual Annual Sponsor Texas Capital Bank.