With the ‘New Normal’, supply chain and market diligence will be highly critical to test

underlying operating assumptions in business plans.

T he pandemic, and the resultant national and international lockdowns, are significantly impacting the businesses of companies.
While it has caused some temporary impact in the short to medium-term, some are expected to cause permanent changes. In this scenario,
closing deals will be challenging.

The disruptions will impact earnings, cash flows and working capital, and it will be critically important for companies to clearly factor in
these impacts in their third-party due diligence plans. In the following paragraphs, we explain the impact of these challenges and what
companies can do to mitigate them.
With the ‘New Normal’, supply chain and market diligence will be highly critical to test underlying operating
assumptions in business plans.

We believe that the crisis will bring about a number of temporary and long-term changes in businesses. It will be important for companies to
assess the impact on their immediate business outlook and long-term projections on account of these short-term and long-term changes.

Some of the temporary changes on businesses include (i) decline in discretionary spends on sales volumes (ii) disruptions in supply chain
(iii) restrictions on travel (iii) delayed availability of migrant labourers to restart production (iv) changes in exchange rate and commodity
prices and (v) lower cost of funding due to expected fiscal stimulus. On the other hand, some of the permanent or fundamental changes
from the crisis could include (i) changes in business models due to enhanced use of technology and work from home, resulting in cost
reductions (ii) changes in market share due to loss of customers (iii) impact on companies engaged in hospitality and tourism, among some
others, which might have to relook at their business models.

Going forward, it might be necessary for companies to prepare comprehensive monthly projections for the next two years. These projections
should be supported by detailed assumptions using present and historical data, transaction-level information (to articulate performance in
challenging times in the past), and management plans. These projections will likely be subject to intense financial and operational diligence,
including sensitivities using various scenarios.

Companies may require transaction and operational diligence to focus on the immediate and long- term steps being taken by
management to build a higher level of resilience. These steps may include changes in the business model and assessment of ‘new
opportunities.’

COVID-19 has led to massive disruptions in working capital cycles and cash flows, which are unlikely to normalize in
the short-term

We believe that the current situation will bring about significant short to medium-term changes in the working capital profiles of businesses.
With a key focus on cash conservation, the impact of increase in receivable and payable cycles and inventory depletion will vitiate the
normalized working capital cycles of various businesses. Companies will have to present diligence-backed, long-term working capital data,
preferably on a quarterly basis, to substantiate normalized working capital requirements of the business.

Additionally, cash flows will need to factor near-term capex to restart plants in case of manufacturing businesses and capex on technology
due to work from home, specifically for companies in the technology and services sectors.

Deal-makers would need to do a far detailed diligence, including operational changes on monthly cash flow projections, to arrive at
normalized working capital trends for the future. Incrementally, they would need to do deep diligence on closing working capital to
ensure recoverability/accuracy of reported numbers.

Deal structures may have greater likelihood of earnout and convertible type structures to bridge bid-ask gaps

We believe that with the given uncertainties in business conditions and difficulty in estimating the normalized earning potential of various
businesses, the deal construct is likely to change in favour of earnout models. Both sellers and buyers will need a sharp focus on parameters
used including revenue, costs, EBIDTA for computing these earnouts/converts to avoid any disputes and undue advantages for either side in
the future.

The article has been co-authored by Partners of the Transaction Diligence team at EY - Kuldeep Tikkha (National Leader), Atul Mehta,
Ashish Singhal and Sunil Gangwal.

Summary
Most importantly, trust with stakeholders and the steps to build a greater level of trust, will gain even more relevance in the new world.