Post-Pandemic M&A Due Diligence: The Way Forward

The outbreak of the unprecedented COVID-19 pandemic forced economic activities worldwide to come to an undesirable standstill. It pushed the global economy into a sharp recession and its side effects continue to adversely affect the markets to date. The swift spread of this deadly virus caused disruption of manufacturing capacity, labor markets and trade routes. Damaging ripple effects were also felt and continue to impact mergers and acquisitions (“M&A”) transactions across the globe. M&A activity fell to its lowest level in ten years globally in 2023. Strict lockdown norms, travel bans, and the switch from a physical to a virtual environment halted negotiations entirely and posed serious complications for an eminent aspect of any M&A transaction: due diligence.

Although the pandemic has passed and the world is back to normal, one change appears permanent: the switch from physical to virtual data rooms. According to M&A advisers, the pipeline of deals going into 2024 looks healthier compared to the same period last year. This upswing in transactions warrants a full-proof diligence strategy, as the M&A world gets comfortable with virtual data rooms. Virtual diligence is definitely more time and cost-efficient. However, it does have its drawbacks, namely it could lead to potentially limited access to data or hastened approaches to due diligence. It is thus pertinent to adapt virtual due diligence procedures in a way that benefits parties in terms of time and cost without compromising the very basis of undertaking such diligence.

What is due diligence?

Due diligence is a process of investigation, inquiry, and verification of a potential investment opportunity performed by investors. It is an important business technique to consider before making any key business decisions or acquiring a company, involving examination of several aspects like corporate structure, supply chains, litigation, licenses, finance and employment, all under a microscopic lens. It not only assists the investor in understanding the extensibility of the potential investment, but it also helps the seller to determine the true valuation of its business. Depending on the size and industry of the transaction and the client’s personal preference, the due diligence conducted may be ‘red-flags’ only, full-scale and in-depth or hybrid.

COVID-19 induced challenges

The conversion from a physical to a virtual business environment has resulted in challenges with respect to credibility and the ability to substantiate information, adversely impacting the very basis of due diligence. Due to restrictions on physical visits, company employees could not physically inspect key original documents of the target company, which are essential to conducting due diligence properly. Many investors fear that limited or no physical access to target personnel restricts their ability to assess the target’s culture, tour its offices, or even complete an evaluation of the target in a sufficient manner.

Acclimatizing to virtual due diligence

Acclimatization and enforcing suitable norms in response to these challenges is a practical solution. Protocols for digital documents and digital onsite visits, assessing credibility via video conferencing, virtual on-site visits, and stricter monitoring to prevent third party frauds, are all key in the world of virtual due diligence. In light of virtual due diligence, set out below, are alternate approaches which can be considered:

Employees: In light of the shift in the work environment, it is relevant to review the target’s remote work policy, infrastructure and employees’ medical and pension plans to determine any adverse impacts on funding. Special focus on the health and safety of the workforce along with periodic monitoring and compliance with labor laws also assumes high relevance. Other employment issues that need to be scrutinized include the pandemics impact on the workforce in terms of absence, annual leave, health and safety.

Commercial contracts: The pandemic has increased the importance of certain contract clauses. In particular, any diligence requires assessment of any force majeure, material adverse change and other termination rights clauses – specifically applying the pandemic context – so as to identify triggers of such force majeure, material adverse change and other termination rights.

Real Estate: Agreement negotiations for rent reduction or deferrals and force majeure clauses with respect to lease provisions requires emphasis during real estate due diligence. Some temporary alterations with respect to safety and access to such properties also need detailed attention to make sure these have been reversed. Buyers should analyze whether the target has been paying rent under its leases and/or whether the target’s tenants have been paying rent under its leases currently, whether any deferrals or other modifications were made in light of the pandemic and whether these have been reversed.

Litigation: Due to restricted functioning of courts during the pandemic, all litigation matters consequently suffered an inevitable delay. Parties may, therefore, need to consider this delay risk when evaluating a transaction. Due diligence should involve assessing the impact of such delays on the target’s pending litigation, as well as anticipating future litigation in light of potential invocation of force majeure clauses, breach of contractual obligations, or even labor-employment matters.

Other aspects: The target’s ongoing operational activities and compliance with central and state implemented laws to combat COVID-19, must be strictly scrutinized as a part of due diligence. Further, the target’s proposition with respect to tax payments and deposits, projection of interest expense, and identification of physical location with remotely working employees as a permanent establishment should all form part of a duly planned, efficient due diligence.

Conclusion

Virtual due diligence is the new normal, and the faster companies adapt, the more efficient they will be in effectively mitigating acquisition risks. Implementing new and modern technology can be a huge step in this direction. With improvements in data management, connectivity, better record keeping, and video calls, many forward-looking investors are infusing technology to weed out the inefficiencies. Virtual due diligence forces investors to get comfortable with remote deals and there has already been tremendous progress since the pandemic, especially in the venture capital space. Out of ninety-six percent of venture capitalists open to remote deals, forty-two percent are willing to alter processes to enable this, and forty percent of the venture capitalists have already done a fully remote deal. These numbers are only bound to increase in this post pandemic business world which promotes ‘survival of the fittest,’ making it imperative for companies to adapt to such virtual data rooms as quickly and efficiently as possible.

Anushka Shah is a LL.M. (Corporation Law) candidate at NYU School of Law and serves as a Graduate Editor of the NYU Journal of Law & Business. Prior to attending NYU School of Law, Anushka worked for two years as an Associate in the General Corporate (M&A and private equity) team at Shardul Amarchand Mangaldas & Co (one of India’s largest and leading law firms) at their Mumbai office. At Shardul Amarchand Mangaldas & Co, her practice largely focused on advising clients on a wide range of public and private cross-border M&A and private equity transactions dealing with industry-specific, foreign exchange and securities laws. Her role involved conducting due diligence, drafting and negotiating transaction documents, particularly in the pharmaceutical and electric vehicles sector.