The Denver Post | BUSINESS
By GARY MILLER | GEM Strategy Management
PUBLISHED Sunday, April 26, 2020 at 6:00 a.m.
Without a doubt the coronavirus is having a significant impact on M&A transactions. Hundreds of thousands of business have closed or significantly cut back on their business operations; millions have been laid off or furloughed; consumer spending has plummeted; supply chains are disrupted; and oil prices are bouncing around at all-time lows since World War II.
At the very least, many deals are being put on hold, acquisition plans are being cut back, and some buyers are walking away from the closing table. Buyers are forced to examine their own companies as they struggle to minimize losses and pay, furlough, or lay off workers. According to Forbes, Xerox walked away from a $35 billion bid of HP this month stating “. . . it [Xerox] needs to focus on the impact of the coronavirus outbreak on its business”. Other examples that Forbes noted was SoftBank terminating its $3 billion deal with WeWork and Hexcel and Woodward calling off their “merger of equals” as a result of the pandemic.
In addition to the widespread lock-downs and shelter-in-place orders, preventing/limiting face-to-face contact, all are contributing to the slowing of M&A activity. For example, due diligence and the manner in which it is conducted is limited since face-to-face interactions are almost always required. Negotiations are strained when the deal team is working remotely. Debt financing is questionable in volatile markets. Securing approvals from regulators and third-party consents are slow.
According to Dealogic, “The value of M&A activity in the first quarter was significantly lower than the last quarter of 2019, down 35% globally and 39% in the U.S.” Investment bankers have concluded “. . . that most all sell-side engagements are being put on hold until things stabilize”.
What small businesses should expect going forward if they expect to sell their businesses or raise capital
- Deals currently in the pipeline and deals entered into during the coronavirus pandemic will move more slowly than during pre-pandemic times. Everything will take longer including initial discussions, letters of intent, due diligence, and negotiations of the definitive agreement. One factor affecting the extended period for closing a transaction is simply the lack of face-to-face meetings which is all but prohibited now. In this environment, new issues of risk management arise from buyers who will want to shift more risk to sellers.
- Valuations of businesses, in certain industries, will be driven down significantly as buyers fear that previous valuations may no longer apply. Public stock market valuations since February 2020 are good examples. Understandings between buyers and sellers about conditions to “walk away” from a deal as a result of future value creation will be more frequent. Prior to the pandemic, almost all transactions were paid in cash or cash and stock. In this environment, sellers should be prepared to negotiate payments in stock only, earnouts and/or milestone payment structures if the sellers’ companies have been adversely affected by the pandemic. Often, these kinds of structures bring buyers and sellers together, particularly when the parties cannot agree on the valuation of the company.
- Debt financing required by purchasers for funding acquisitions will be harder to find, resulting in delays due to the unstable debt markets and lack of liquidity. In addition, lenders’ closing conditions will be more stringent, affecting both buyers and sellers.
- Letters of Intent, term sheets, memoranda of understanding (which are non-binding for the most part) will either expand to nail down more specific deal terms or address only the price and little else.
Proformas will be examined closely and will be heavily discounted as buyers tiptoe into uncharted waters in the future. Buyers will spend more time in initial discussions with sellers before spending money to conduct comprehensive due diligence reviews and analyses. Sellers should expect more attention being paid to the effects of the coronavirus on the buyer’s business going forward. Sellers, on the other hand, should push hard to limit the time period of the due diligence process to as short a period as possible.
- Exclusivity periods (preventing sellers from soliciting other offers during the due diligence process) will be longer than the normal 30-45 days, as buyers will insist that they need more time, 60-75 days, to examine potential pandemic issues. On the other hand, sellers should seek provisions terminating buyer’s exclusivities if they see that buyers are unwilling to proceed with the transaction as set forth in the letter of intent.
- Negotiations of the definitive agreement will include provisions focusing on changes in the business operations of the seller’s company – referred to as a “Material Adverse Effect” (“MAE”). These provisions affect the closing conditions of the transaction. It permits the buyer to walk away from the deal if the seller has suffered a MAE during the period from the signing date of the definitive agreement through the closing date of the transaction. Sellers should be careful about MAE clauses. They should negotiate “carve outs” that buyers and sellers agree to, in advance, that will not constitute a MAE. Sellers should seek expert legal advice from a transaction law firm that protects them, as much as possible, from MAE provisions.
Is there any good news during the current pandemic environment?
Yes. Many buyers are cash rich (dry powder) and are hunting for well-run companies at the right price. Dealmaking going forward will favor buyers vs. sellers as it did during the Great Recession. Buyers are taking time to search for the best opportunities. Some industries have benefited from the pandemic while others have suffered significantly. Industries benefiting from the pandemic include biotech, food delivery, online shopping, cloud computing, software, videoconferencing and other technologies.
By contrast, retail, hospitality, travel, hotels, restaurants, automobile, and airlines have been and will be impacted the most dramatically.
Business owners planning to sell their businesses or raise capital should realize that their options have changed significantly. Whether selling companies or raising capital, owners should take extra care to prepare their businesses for sale. Keeping key employees is mandatory as buyers will put extra emphasis on the bench strength of the business. Individual and collective incentive retention plans for your most valuable employees should be created.
In a world where physical contact is next to impossible, transactions are handicapped to say the least, so sellers should think through, with their advisors, how best to navigate and communicate in a digital environment vs. a face-to-face environment.
Deals are being completed in this environment; so be patient, prepare well for video conferences. Consider choices of background, lighting and clothing for the best impression. Be careful about exposing your non-verbal facial reactions when you are on a video conference call. Finally, if you are unsure of your proportioned response to an issue that could be contentious, ask for additional time to consider a thoughtful response. Handle to the new realities with confidence and optimism! Your positive attitude will instill trust during a time when many are feeling uncertainty.
Gary Miller is CEO of GEM Strategy Management, Inc., a M&A consulting firm that advises small and medium sized businesses throughout the U.S. He represents business owners throughout the transaction process from preparing them to go to market, selling their companies, acquiring companies and raising capital. He has been a frequent keynote speaker at conferences and workshops on mergers and acquisitions. Reach Gary at 303.409.7740 or firstname.lastname@example.org.