For successful M&A deals during the crisis and post-pandemic, understanding valuation, negotiation, and deal structure is essential.
By: Monica Vir, Esq., Partner, Lindabury, McCormick, Estabrook & Cooper, P.C. and Steve Raymond, Managing Director, The DAK Group
Every business owner has entertained thoughts of selling their company at some point, but often without a clear picture of how to do so, and an even less clear picture of how to do so during a pandemic. Every business has something other businesses want – sales, talent, manufacturing or distribution capacity, unique qualities, access to a desired market, or the ability to create additional value through synergy. So, if a business wants to sell now, what can it expect during and after the crisis in terms of deal structure and valuation?
As the post-pandemic economy shifts toward recovery, strategic M&A deals over the short term will be driven by two factors: distress and opportunity. Strategic investors, with record amounts of cash on their balance sheets, are now under even more pressure from their investors to deploy that cash to increase growth. Private equity investment groups, with an estimated $1.5 trillion of dry powder, will continue to be a significant factor in Middle Market M&A. This capital has time restraints and needs to be deployed expeditiously in order to create return, driving private equity investment.
Both healthy and distressed companies will be targeted by these perspective buyers. Healthy companies that survived and those that thrived during the pandemic can bring stability and strength to potential buyers who may be willing to pay a premium for this added value. Businesses that fell on hard times during the pandemic and have become “stressed” or “distressed” may be looking for a quick exit and be willing to take offers that, pre-Covid, they would not have considered.
Different sectors of the economy have experienced varying degrees of pain in the pandemic shutdown. Whereas some businesses have remained open and thriving, such as manufacturers and distributors in the food sector, others have felt the significant burden of the government-imposed restrictions, particularly in the retail, travel, and hospitality sectors. The same is true of the M&A market, and business owners need to be aware of how their sector has performed. M&A expectations for privately held businesses are highly specific to the industry and how the business preformed prior to and during the crisis.
Understanding Where the Business Value Is
The reality of a business sales process is that the value of a business is determined by the buyer as much as any other factor. One of the biggest mistakes is when valuation is simply set based on a multiple of EBITDA. This “simple” calculation leaves millions of dollars on the table and less in the pocket of the seller. It is the seller’s responsibility to “paint a compelling picture of the future”, allowing prospective buyers to understand the accretive value the acquisition can bring to them; and substantiating a price that usually exceeds the simple EBITDA multiple calculation. The same business could be viewed completely differently by two different buyers, depending on their strategic needs and their perceptions of the future.
The business sale process also plays a big role. Buyers tend to pay much more for a deal that they believe is competitive. From a deal making perspective, running a competitive bid process and finding the right buyer for the deal involves broad based search, discipline, a substantial amount of negotiating, creative deal making, and people management skills. For the seller, the competitive process provides optionality, allowing them to negotiate on various terms to drive the value and the optimal outcome. Ultimately, it comes down to what a buyer can pay and what a seller can accept.
The best way for business owners to earn the maximum value for their company is to plan early and hire knowledgeable M&A and legal advisors who can help strategize, orchestrate, and negotiate the sale.
Impact on Deal Structure
One impact of the crisis has been a shift from a seller-friendly market to a buyer-friendly market. This has been most evident in the negotiation of the following provisions: payment schedules and earn-outs, and the definition of material adverse effect as it pertains to representations and warranties and interim operations. The common theme underlying negotiation of these provisions is uncertainty. Specifically, buyers want to ensure that if there is a downturn or some other unexpected event (such as a second wave), that the seller either shares in the downside risk or bears it entirely. Uncertainty will require all parties, and especially a seller, to also accept its corollary – flexibility.
Payment schedules may be longer to adjust for seasonal (and second wave) impacts and buyers may want earn-outs to ensure sellers have been straightforward as to the overall picture they painted for the buyer. Sellers will likely want a carve-out for pandemics to the definition of material adverse effect so as not cause a representation and warranty to become untrue or trigger a breach of covenant to operate the business in the interim in the ordinary course. Although buyers may be willing to accept this carve-out, they may request that it have an impact on a seller’s operations specifically. Much like determining the purchase price, negotiations of these terms will require striking the right balance and being mindful of the risks each party is willing to accept (or not accept) to move the deal forward.
Painting the Picture for the Future
The key messages for business owners looking to sell their businesses in the short term:
- Be able to articulate your company’s strengths and how they will enhance business value for a buyer.
- Be willing to accept a shift in risk attendant to a buyer’s market rather than a seller’s market.
- Select an M&A advisory team that can sell the value of the business to the right buyer, so as to maximize benefits for all parties.
- Plan early and never sell in desperation.
Monica Vir, Esq., is a partner with Lindabury, McCormick, Estabrook & Cooper, P.C. (www.lindabury.com). As co-chair of the firm’s M&A Practice Group, Ms. Vir has successfully represented both acquirers and targets in complex M&A transactions. Based in Westfield, NJ, Lindabury serves clients, including prominent corporations and businesses, throughout the Mid-Atlantic region.
Steve Raymond is managing director of The DAK Group , a 35+ year M&A advisory firm/investment bank (www.dakgroup.com). Based in Rochelle Park, NJ, The DAK Group works exclusively with Middle Market businesses to maximize the value of the company through divestitures, acquisitions, valuations or restructuring – guiding both healthy and distressed companies, over 650 transactions in all key industries.