The COVID-19 pandemic put a temporary halt to virtually all M&A transactions earlier this year, and for good reason too. We’re about seven months into the pandemic and the future is still uncertain with no clear path forward. We are starting to see more deals put back on the table and buyers are reemerging to hunt for opportunities. The question is, how do sellers, buyers, investors, and their advisors find common ground to navigate these uncharted waters?
As necessity is the mother of innovation, business owners and their advisors are adapting to the realities on the ground, developing unique strategies and deal structures to mitigate / quantify the risks of COVID in order to move forward with M&A opportunities.
The Impacts of COVID-19 on the M&A Market
1. At its core, the volatility and uncertainty we are experiencing due to COVID-19 simply leads us back to the fundamental question of how to effectively manage and quantify the risks of a potential transaction or equity investment. Valuation is typically derived by discounting the expected cash flows for the associated risk of the cash flow stream. It is the assessment of all known and unknown risks and the potential events that could impact the return of capital to business acquirers and investors. With this framework in mind, COVID 19 is simply another risk that must enter the equation.
2. We are beginning to see a shift from a sellers’ market to a buyers’ market. During the preceding years of an expanding economy and general bull market, valuations steadily increased, and buyers – both strategic and financial – had access to an abundance of excess capital to invest. Equity investors have been eager to deploy equity capital and debt has been historically low. This has been visible in all corners of the market from early stage, venture-based investors in search of the next unicorn, all the way to mature, multi-billion-dollar corporations merging or acquiring competitors. Buyers were willing to pay for growth with higher valuations rather than building it organically.
3. The daily inquiries from search funds, corporations, high net-worth individuals, and private equity groups looking for acquisition opportunities that fit their investment thesis have not stopped throughout the pandemic. However, there is a slight shift from “Do you have anything?” to “Do you have any opportunities?” and that represents a real, fundamental difference.
4. As acquirers narrow their focus and screen for better deals, they will filter out more potential transactions or make valuation adjustments to protect their downside risk. This downside protection will come in the form of walking away from potential deals, a decrease in valuation offer or an adjustment in terms to mitigate the risk and widen the gap. One interesting caveat to this is we are starting to see an increase in valuation and demand for companies that have mitigated both normal company specific risks and COVID risk. In other words, companies that were not impacted by COVID will more than likely warrant higher valuations and be more in demand.
5. In today’s world, all risk and uncertainty will be magnified and due diligence increased to understand these risks and the impacts of the related uncertainty. Traditional company specific risks like owner involvement in the business, customer concentration, inconsistent revenue streams, supply chain, and other factors will have to be thoroughly understood or sellers will face significantly decreased valuations and less favorable terms.
How Can a Favorable Transaction Get Completed in Today’s environment?
As we transition from a seller’s market to a buyer’s market, sellers will need to be more flexible and creative in how they allocate the potential risk of a transaction. They will also have to double down to ensure that processes, systems, and financial records are in order and that the business will pass the scrutiny of a more intense due diligence process. Sellers may elect to wait for more favorable conditions, but unfortunately that is a risk as there are no guarantees that the market will switch back.
The good news is that conditions are still ripe for win / win acquisitions. Individual, family offices and private equity buyers have an abundance of capital to invest, access to low interest debt and a strong desire to deploy capital. Strategic buyers will look for transactions that enable them to add market share, create synergies, or add new products, service lines, or additional employees.
In today’s world, getting a mutually beneficial transaction completed boils down to managing the uncertainty of the COVID risk and spreading that risk out to the satisfaction of all parties involved.