After last year proved to be a record year for both registered investment advisers (RIAs) and independent broker/dealers (IBDs) in terms of merger and acquisition (M&A) activity, 2020 got off to a quick start.

As detailed in new data provided by Fidelity Investments, financial services M&A activity in the first quarter started o­ff strong, with 20 RIA transactions in the first two months of the year, representing $28.7 billion in client assets and exceeding assets under management (AUM) totals for all of the first quarter of last year.

However, as market volatility and the COVID-19 pandemic unfolded in March, M&A activity clearly slowed, Fidelity reports. By the end of the quarter, just three more RIA deals were inked, bringing the total to $29.9 billion in client assets. In the end, the quarter’s RIA deal volume was down 26% in terms of the number of transactions, but up 35% in client assets compared to the first quarter of last year.

Those figures have M&A experts contemplating what the second quarter, and indeed the full year, will bring in terms of deal volume. Michael O’Bryan, a partner in Morrison & Foerster’s mergers and acquisitions group, notes there are many transactions that are currently in the interim stages—with deals signed but mergers incomplete. He expects these deals will more or less continue as envisioned, but the negotiation and signing of new deals may slow significantly.

O’Bryan says it is unlikely that deals that are now unfolding will unravel, though they may take some additional time to receive full regulatory approval as the functions of government also slow.

“If you have already inked a deal, you are still governed by what is in those acquisition agreements,” O’Bryan says. “Of course, what has happened to the parties in the interim period very well may change how they feel about the deals they are now locked into, but that doesn’t mean they will have an easy way out.”

When it comes to the financial services space, many deals have been structured in terms of stock-for-stock consideration, which should ease some of the pain being felt by purchasing parties. In other words, the stock values of both companies being transacted have probably been affected in a fairly even way, meaning neither party is “benefitting” relative to the other from the new economic situation.

“Typically, if it is a stock-for-stock merger or acquisition agreement, you may find that while both parties have been hit pretty hard by this situation, they might both have been hit relatively the same,” he explains. “And looking forward, they are both facing the same issues, and so in a stock-for-stock deal there may not be as much of an impact as you would expect.”

Cash-based deals are different, though.

“In a cash deal, you can certainly imagine the attitude of the person who is supposed to be spending the cash might be a bit different today versus two months ago,” O’Bryan speculates. “In fact, while they already were benefitting from a sellers’ market, the cash price the seller is going to receive may now seem even more attractive. On the other hand, if you are paying cash to acquire a company, you may now feel like the contracted amount is too great.”

In O’Bryan’s extensive experience helping to structure such deals, sellers will typically ensure that it is the buyer who carries this cash risk into the transaction. Generally, there is not going to be much recourse for buyers who are paying early 2020 prices for businesses that are now facing a pandemic-triggered recession—or worse.

“The risk is frankly often put on the buyer in these contracts,” he explains. “Usually, in order to void such a contract, any so-called ‘material adverse effect’ experienced on the part of the company being sold is going to have to be very specific and limited to that company—for example if serious fraud is uncovered or something like that. The impacts of an epidemic or a global recession do not usually constitute a material adverse impact under the typical M&A contract.”

Looking forward, O’Bryan offers the following practical steps that business leaders should consider to navigate M&A amid the unfolding pandemic:

• Material Adverse Effect: Courts generally have set a high bar for finding that a material adverse effect (MAE) has occurred with respect to a target company during the acquisition process. Still, in many acquisition agreements, the acquirer will not be obligated to close if the target company suffers a MAE or breaches its representations and warranties to a point resulting in a MAE.
• Pre-Closing Operational Covenants: Acquisition agreements commonly provide that, between signing and closing, the target company must conduct its business in the ordinary manner. Those attempting to finalize a deal should provide further clarification with respect to the interim operating covenants. The target company needs to seek to clarify its right to take steps in response to the outbreak, and the buyer should seek to confirm that it is not obligated to acquire a company that has not had to comply with the operating covenants.
• R&W Insurance: In any acquisition agreement, parties generally should assess whether the COVID-19 outbreak may require changes in, or additional disclosures with respect to, the representations and warranties made. Those seeking “rep and warranty insurance,” or “R&W Insurance,” should also be mindful that insurers are developing underwriting protocols to address COVID-19-related risks. Some insurers are proposing excluding coverage of business interruptions and other business downturns arising out of the coronavirus.
• Regulatory Approvals: Since face-to-face interaction at the government level has ceased, it is likely all regulatory approvals may take longer than usual. To accommodate delays, parties need to consider the steps they must take and the mechanisms needed such as providing longer than usual “outside dates.”
• Financing and Consideration Issues: The COVID-19 outbreak has rattled equity and debt providers along with acquirers and target companies. In this context, a target company should confirm whether an acquirer’s debt and/or equity financing sources remain available and check on the financing options that are offered.
• Due Diligence. Given the challenges of having to work remotely, the process for conducting due diligence will need to change in response, taking advantage of technologies such as videoconferencing and virtual data rooms. Acquirers will need to seek further understanding of the effects the virus has had on the target company.