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  • M&A Deal Making Post COVID-19

    Apr 21, 2020

    Successful mergers & acquisitions intermediaries possess three professional attributes: knowledge, experience, and ability. Knowledge can be gained academically or through mentorship.  Experience can only be gained from repetition of the deal making process in transactions with a spectrum of different variables ranging from industry to geography to economic environmental issues including interest rate fluctuation, labor market demand, tax rate variance, and national & local economic cycles. Knowledge and experience can be vested individually or institutionally. Ideally, a retained M&A broker will possess these attributes individually and be affiliated with an established firm that has them institutionally. Knowledge & experience are the foundation of success for a business broker. It is critical that an M&A professional knows how to effectively value a business, create a marketplace for the company, and the process necessary to complete a transaction employing “best practices”.

    These elements often allow for a business broker to sell a quality business in a stable economic environment.  Unfortunately, economic stability has not been in the forecast for 2020.  In economic times like we are experiencing this spring the professional skill of the intermediary will often play a more significant role in getting the deal successfully to closing than knowledge and experience. The professional skill sets of the top M&A intermediaries include strong listening skills; superior communication acumen both verbally and written with a comprehensive understanding of relevant legal, accounting, investment, business, and/or real estate concepts; and the ability to problem solve through dynamic, sophisticated issues in real time.

    Relevant knowledge & experience play a significant role in a business broker’s ability to problem solve, as they are the source for the menu of options to address a given situation in a negotiation.

    An anticipated issue in deals in the second half of 2020 will be the appropriate allocation of risk between the parties. Deals will occur in 2020 where buyers purchase businesses for 100% cash.  The values in these deals will be based on the perception of risk on both sides of the table.

    Perception of risk by business buyers will also result in negotiations where the seller is asked to modify expectations to reflect present economic and market conditions. The following are a few of the problem-solving strategies likely to be employed to get buyers & sellers to “yes” by professional intermediaries in 2020.

    1. Deferred Closing Date – How municipal, state, regional, and the national economies respond when they are progressively allowed to return to normal is unknown at this time. It is anticipated that the velocity of the bounce back will vary based on the local economy; municipal, state, & federal government strategies, support, and restrictions; the industry of a business; the specific attributes of a company; and the ability of executive management. It is reasonable for a buyer to delay closing until a time when these elements can be more accurately accessed.  A business that mirrors or exceeds June 2019 performance in June 2020 will at initial assessment appear to have weathered the COVID-19 storm successfully.  Depending on the industry and seasonality of the business model it may take more than a few months to properly assess the impact of the Coronavirus on a specific company.  It is a reasonable ask for a buyer trying to properly price a company to defer the closing date until appropriate data can be collected.
    2. Earn-Out – One methodology for allocating risk between a buyer & seller negotiating in “good faith” in a time of uncertainty is to create a variable, performance based financial component in the deal. It is my recommendation if this deal element is incorporated into a deal that the parties first agree on a baseline value that both sides feel is justified based on anticipated conservative projections for the performance of the company in the next 12 months. The variable element would be added to that value after an agreed time period based on the performance of the business.  The advantage of this element is that the seller is paid a fair value relevant to the performance of the company and the buyer only pays for what is delivered.  Two disadvantages associated with employing this element are that future performance can be impacted by the management ability of the new owner and banks will traditionally reject the inclusion of a variable performance element as a deal component because it prevents the ability to calculate future debt service coverage with a high degree of certainty.
    3. Seller Financing – A variation on an earn-out that will be accepted by some banks is a principal credit against a seller promissory note, if company performance is below an established threshold. The reason this element is acceptable to some financial institutions is the maximum amount of debt service can be calculated.  A reduction in debt service or the sale price with a principal credit to a promissory note will not impact this high-water mark of future payments calculated by underwriting.
    4. Retained Equity – A risk allocation strategy that encourages seller engagement in facilitating a smooth transfer of ownership and the future performance of the company is to have selling ownership retain an equity stake in the company. This strategy has the potential to result in a higher price being paid for the business, if the company increases financial performance and market share post transaction.  Many buyers view this negatively as they wish to pay for what they purchased, not what they bring to the company as an acquirer.   If equity is retained it is recommended that the legal documentation have a clear mechanism for valuing the equity and an established timetable for a seller to have the option of being cashed out.
    5. Retained Employment – One strategy to mitigate transition risk is to retain existing ownership in an executive management capacity post sale. The term and compensation for retention can be anything agreed to between the parties. One strategy employed by buyers is to overpay a retiring president of a company for their continued employment post sale.  The advantages of this strategy include the ability to write off the value over a shorter period of time versus 15 years if the value was allocated to goodwill in an asset purchase and keeping the seller emotionally & mentally engaged through knowing that a portion of their sale price value is tied to management performance during the transition of ownership.

    The goal for all mergers and acquisitions intermediaries is to get the parties to “yes” and complete the transaction.  Knowledge, experience, and ability are the three ingredients needed to achieve that goal.  Significant M&A activity will occur in the second half of 2020.  I am projecting IBA’s team of seasoned, highly skilled business brokers will be busy deal making in the Pacific Northwest.  We have successfully completed over 4000 transactions and navigated through turbulence in the economy numerous times in our 45-year history as the premier main street & middle market intermediary firm in the region.   If you are looking to sell or buy a privately held company or family business in 2020, we would welcome the opportunity to provide an overview of our services.  100% of IBA’s fees are payable upon completion of a transaction by satisfied clients.

    IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.

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