The Covid-19 pandemic has given operators and investors in the care home market new factors to consider when assessing acquisition targets.
Please note: the information contained in this legal update is correct as of the original date of publication.
The Covid-19 pandemic has given operators and investors in the care home market new factors to consider when assessing acquisition targets. Prior to the onset of the pandemic, activity in the care home market across all sectors was at a high level with plenty of interest from established providers and new entrants, including private equity.
The onset of the pandemic had an obvious and immediate impact on M&A activity generally – with potential acquirers and investors looking to keep hold of cash and assess impact, and potential sellers focusing on ensuring their businesses continued to trade profitably and able to mitigate risk of Covid infection.
In the period since lockdown, across much of the care sector, trading has held up albeit in the face of considerable operational and financial challenges. The need for care has not gone away. In fact, in many areas of specialist care, the demand has increased – relatives have needed to accelerate decisions for shielding or other domestic reasons created by Covid. Investors and acquirers on the other hand have, in assessing the market and potential targets, particularly in elderly care, placed greater emphasis on stress-testing the cashflow models of targets in the event that infection enters the home or compromises staffing levels.
At this point in time, only the strongest performing businesses will stand up to such rigorous analysis. This has left many businesses, which would be attractive propositions in ordinary market circumstances, in a state of limbo.
The typical challenges many operators are familiar with, such as tight margins on funded placements, availability of quality staff in certain regions and the ever-increasing regulatory burden, have been exacerbated by the impact of the pandemic. These impacts include:
The early signs are suggesting this may well push some otherwise profitable and well-run homes into distress. On that basis, and as existing cash reserves dry up, one would expect the number and average quality of distressed opportunities on the market to increase and improve.
As a consequence, those seeking growth through acquisition are exploring new ways of increasing their stock and picking up a distressed business at a price reflective of real value for money. It would come as no surprise if, post-pandemic, many investors increasingly factored distressed opportunities into their investment strategy.
It is perhaps trite to say it, but businesses don’t go bust because they aren’t profitable. They go bust because they run out of cash.
There are multiple reasons why a perfectly good care business may find itself in the position of being ‘distressed’, many of which are not terminal and a number of them are summarised above. This creates opportunities to acquire at a discounted price which can, even when factoring in the expense of fixing what has gone wrong, represent real value for an investor (particularly cash buyers due to their ability to act quickly and possibly even negotiate a lower price reflective of that).
Due diligence on the part of the investor is key to establishing whether the business in question presents such an opportunity. Ultimately, investors need to identify the following and quickly (the risk of the business’ position worsening comes with pressures of its own from a transactional and operational/regulatory perspective):
If the assumption that the home has simply been badly run can be put to one side (it is often an oversimplification of broader issues), the potential investor can drill down into the business’ underlying challenges. Some key commercial areas of enquiry which are likely to be towards the top of that list are:
Getting an answer on the above is at least a start for a potential investor to determine whether the business is ‘a diamond in the rough’ in need of a little investment or one to be avoided. The investigations should also help distinguish between chronic or recurring issues and those issues which are attributable to unusual events, such as Covid-19.
The extent to which you can rely on warranties and how valuable they are will depend on a number of factors including:
Warranties are an important part of any corporate transaction. For an investor/acquirer it provides them with a form of retrospective price adjustment in the event that the business or company they are buying is not as it was presented to them.
As the investor/acquirer, if you are able to negotiate a reasonable set of warranties and you are satisfied that the seller will be able to meet any resulting liability, you may be satisfied that you can ‘fall back on a claim under the warranties’. In any other situation (i.e. you pay a little less on the basis that you will not get the benefit of warranties, you are not satisfied with the covenant strength of the vendor or you are not comfortable with the extent of the warranties offered), the evolution of warranty and indemnity insurance (W&I Insurance) could provide you with a neat solution.
Historically, whilst the M&A market was strong, insurers did not tend to look to provide W&I Insurance on accelerated or distressed M&A as the product needed to be adapted to fit and margins would likely be lower than higher value, non-distressed deals. However, with deal volumes down across all sectors, and awareness and availability of W&I Insurance as a product probably at an all-time high, insurers have expressed a willingness to support accelerated or distressed M&A and have generated a product which is aimed at transactions of that nature. Insurance could be used to either:
The second alternative is a relatively new concept and has been created to support accelerated or distressed M&A. Certain insurers have generated a set of ‘synthetic’ warranties and tax indemnity together with a form of due diligence scope. If an investor/buyer can do the due diligence in the scope it should be able to secure the benefit of the ‘synthetic’ warranties/indemnity. Unlike typical W&I Insurance, the ‘synthetic warranties/indemnity’ are negotiated directly between the investor/acquirer and the insurer (and there is no need for a seller to go through a disclosure process in respect of the ‘synthetic’ warranties). Of course, like any insurance, there is a premium to pay which could start at £40,000-50,000. However, it may be a critical piece in effecting the acquisition of a distressed but otherwise potentially viable business (and the consequent preservation of jobs and continuity of care for residents).
The jury is out as to whether or not there will be an appetite for the ‘synthetic’ warranties as they do not avoid the need to do due diligence (which may be a barrier to securing such a policy particularly where the business being sold is in administration or being sold as a ‘pre-pack’) but insurers are keen to deploy these policies and enter the ‘proof of concept’ phase with them.
Through our sector specialist M&A lawyers acting for multiple clients taking advantage of the opportunity to acquire distressed homes, we have a wealth of experience in working to ensure that the acquisition works for them and their growth strategy. Feel free to contact Clare Auty, Joel Nixon, Peter Allen or Ryan Brown to discuss your needs.
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