M&A: Implications of the Global Economic Crisis for CEOs
“There is a huge amount of money in the market. Governments have created money that is going to companies, so the money is there. Buyers are trying to help sellers structure a deal to move forward to 2021 numbers,” says Enrique Quemada, Chairman at ONEtoONE Corporate Finance, during a recent YPO Global Conference Call. He adds a note of caution, “Everyone is trying to figure out what kind of crisis this is. Every day things are changing. Some guys are going to jump in and do acquisitions and others will decide to wait for one year.”
The wide range of implications on corporate acquisitions and disposals are top of mind these days for two other members who joined the discussion — Ignacio Macias, Managing Director at Pysma Iberica and Mark Herbick, Chief Executive Officer at Pursant LLC. Members of YPO’s Deal Network, the three chief executives are maneuvering the current mergers and acquisitions landscape and see a change in practice toward more buyer-friendly provisions and the need for adjustments in valuations and buyer due diligence as both buyers and sellers look at deal protection mechanisms for their transactions.
Market volatility outcomes to date
Herbick describes the impact to date from a U.S. perspective as three-fold. “When an early March time frame hit and lockdown set in, we saw three different outcomes in the M&A world. Anything about to go to the market was put on complete pause. Buyers and sellers were trying to understand the lay of the land,” he says. “Anything under letter of intent, in due diligence (phase), moved at a snail’s pace across all industries because of overall uncertainties … with the movement of these deals contingent on payment.”
The third outcome was deals engaged with businesses that were deemed crushed by pandemic, and these were terminated. “In short, deals in the U.S. dropped by 50% compared to the last year, all in the last three weeks of March. Everyone slammed on the breaks,” says Herbick.
Macias witnessed first-hand the rapid change in dynamics of deal making. “I was in the middle of a transatlantic transaction and had three deals lined up all under LOI (letter of intent). Buyers and sellers had a framework agreement and then COVID-19 comes,” he says. “Right after that, with the growing uncertainty, both sellers and buyers realized that renegotiation was necessary.”
Macias was able to close the first deal by finding creative solutions to bridge the valuation gap, including focusing on building trust, negotiating earn-out provisions linked to milestones and bringing banks to the deal sooner rather than later.
Regional and industry variations
For Quemada, whose company has offices in 42 cities worldwide, the M&A market has varied by region and sector. “In Asia, things are back to normal and we are closing deals. There is freedom of movement. In Europe, in northern countries like Norway, Sweden and Germany, activity is almost back up, especially in private equity. In the south of Europe, it is different. M&A (activity) has almost completely frozen.”
Quemada also adds that companies in sectors that have benefited, like food, are progressing, but with longer, ongoing due diligence. In addition to a lengthier deal process, metrics to calculate earn-out milestones are being carefully considered. “They (buyers and sellers) are talking about change of structure and terms and agreeing on earn-outs.”
While distinguishing between winners and losers across industries and geographies, all three highlight the importance that sellers, who need not sell now, use this time wisely, reorganizing where necessary to prove to future potential buyers their resilient business model.
Post pandemic future
As companies navigate the uncertainties of 2020, Herbick believes that the period of a seller-favorable market has ended and a short period of neutral, leaning to a buyer-favorable market for a year or two, has started.
“There is consensus that there will be a spike of M&A activity on the back half of third quarter of 2020. Many see an increase (in activity) compared to pre-COVID-19 times.” He adds that “this (COVID-19) is a big punch in the face for many business owners, so people sitting on the fence will be motivated to transact, resulting in an increase in volume on the backside of this.”
Sellers, it was also discussed, will attempt to negotiate earn-out provisions that allow for flexible earn-out payments. The appropriate provisions will depend on the willingness of both sides to take risk and the impact of COVID-19 on the target company.
“Payment has been a pain point in middle market companies. Earn outs are very common. But often, it is a deal killer. Parties are not comfortable with earn outs … . But, post COVID, motivated sellers will be more receptive to it while others will walk away,” says Herbick.