On the morning of March 18, my phone rang. As soon as I saw the identity of the caller, I instantly knew the subject matter of our upcoming conversation. The caller was a business owner whom I have known and advised for several years as he has contemplated “cashing out” and selling the successful manufacturing business that he founded over 30 years ago. Common sense and economics consistently argued in favor of selling, but this owner, an eternal optimist, couldn’t shake free of the belief that the opportunities ahead in the next 12 months required his leadership in order to be fully optimized and that the corresponding value created would validate the postponement of his exit.
“Do you think there is still a market for my company?”
After dispensing with the usual pleasantries, he got right to the point and asked the question that I was expecting. He was concerned that the window of opportunity to sell had closed, seemingly overnight. He had bet on himself – a good bet, based on his track record – but the unexpected crisis created by the spread of the coronavirus had fully infiltrated the U.S. and the economy was shrinking by the day. Deal-making was, for the most part, turned off, and companies across the country instead initiated survival game plans, the duration of which was anyone’s guess. The U.S. was headed into uncharted territory and going in the wrong direction.
“Yes, you can still sell your business.”
Since that initial call, our team at PCE has had conversations with many other business owners with similar stories and questions. The velocity of the economic reversal was head-spinning and left many searching for answers and reaching out. For those business owners who were worried that they had ridden the economic wave for too long and were now chained to their respective businesses for the next few years, our counsel is encouraging. Yes, you can still sell your business … b-u-u-u-t, the process is going to be a little more challenging.
“Money Never Sleeps”
So said Gordon Gekko, the fictional character in the 1987 movie Wall Street, as he implored his protégé to stay laser-focused on finding money-making opportunities. This adage is true not only in Mr. Gekko’s Wall Street world but in our world, as well. Deals are still getting done and will continue to get done. Not at the same volume, of course, as existed pre-crisis, but investors with cash on their balance sheets want and need to put their money to work.
What will be interesting to watch will be the response from operating businesses toward M&A activity. In our experience, gained from advising on M&A transactions over the past 25 years, the vast majority of deals involve a strategic acquirer as the buyer – that is, another company in the same or similar industry expanding or diversifying. Strategic acquirers often have an inherent advantage over financial acquirers due to potential cost synergy savings, longer investment horizons, and industry familiarity. How will these companies react as they come out on the other side of the crisis?
Our expectation is that while there will be plenty of companies ready to rev up the M&A machine again, there will be considerable fallout in the ranks of interested strategic buyers. Companies that have been damaged by the crisis will certainly be out of the M&A picture (as buyers), and many others will need months to regain their bearings and stabilize operations. Cash will be of paramount importance to these companies in order to support their operations and, thus, will be unavailable for acquisitions.
So, with a shallower pool of strategic acquirers, what does this mean for the business owners who are ready to sell? They need to become familiar with the buyers who are still eager and have money to spend: financial acquirers, bloated by unallocated capital on their balance sheets – an estimated $2 trillion – that needs to find a home.
Financial vs. Strategic Acquirers
First of all, let’s define “financial acquirer/buyer.” We define financial buyers as investment vehicles formed to invest in companies over a period of time to deliver desired returns. Money is raised from high-net-worth individuals and institutional funds such as endowments and pension funds. While there are many types and categories of financial buyers, the most common and appropriate for this discussion are private equity firms.
A main distinction between financial buyers and strategic buyers is the role of the owner in the company after the transaction has closed. Financial buyers are investing in the company’s management team, so if the owner has been active in the day-to-day operations of the company, he or she would be expected to continue in his or her role for a longer period of time than might be expected by a strategic buyer that might just require a short-term management transition.
While there is understandably a certain comfort in a more straightforward strategic sale for an owner, there is considerably more opportunity for future value when selling to a financial buyer. The biggest challenge in a financial buyer transaction, though, is finding the right buyer. As I mentioned before, there are thousands to choose from in all shapes and sizes. It’s important to thoroughly research the market, get to know your future business partners, check references, make sure goals are aligned, and so forth. There are plenty of great financial buyers, but the challenge is to find the one that is the right fit for you and your business.
Changes to the Buyer Profile
As I noted earlier, there have been substantial changes to the M&A market in response to the crisis. One dynamic that should get some traction will be if the business was considered “essential” and as having recession-resistant characteristics. This is attractive to financial buyers because it obviously lessens the risk factor of macroeconomic pressures. Additionally, most companies in these industries were able to continue operations and may not have to explain traumatic adjustments to their earnings.
The healthiest companies in these essential industries also own the strongest balance sheets and might be looking to take advantage of M&A opportunities available among weakened competitors. As a result, the population of strategic acquirers in these industries might not be dramatically reduced.
We expect a different reality, however, among “nonessential” industries. This is where we believe there will likely be a shift from strategic deals to financial deals. Our discussions with many private equity investors over the past several months have reinforced this thought process. Financial acquirers are using this slowdown time to develop acquisition game plans in a market of reduced competition.
One of the reasons that most transactions are strategic in nature is that strategic acquirers can often offer a higher closing price because they believe there will be synergistic cost savings or revenue growth that a financial acquirer likely can’t match. Financial acquirers can tempt owners with growth forecasts that include “back-end” riches for the owner, and sometimes that works if the owner has a longer time frame.
If the strategic competition is diminished, though, this greatly improves the odds for the financial acquirer to land the deal. As a result, the coming months represent a competitive opportunity on which financial acquirers hope to capitalize.
One term that we have heard frequently in our discussions with private equity firms is “creativity.” In order to capitalize on the competitive opportunity that lies ahead, they will probably need to be more creative in deal structures. This may mean that firms that typically invest capital through a combination of their own cash and some bank debt might find affordable debt less available. As a result, they may have to invest more cash than normal or, perhaps, take minority positions that they would not normally accept.
Creativity has also been mentioned as a method to address potential valuation disagreements with owners who do not agree that their businesses have lost value due to the crisis. Future payouts using nontraditional means, such as earn-outs, might be used to bridge the valuation gap.
Are You Zoom-Ready?
So, assuming that there are willing buyers and willing sellers in the age of today’s “new normal,” how are deals getting done? For better or for worse, in many cases, deals are being transacted without in-person meetings. Old-school personal validations between the two sides such as feeling the grip of a handshake or eye-to-eye discussions across the negotiating table have, in many cases, been replaced by “virtual” interactions over the internet. Zoom, right now the most popular digital platform for hosting internet video meetings, has become integral to the due diligence process in these transactions by providing “contactless” visual confirmation. Critical meetings and even site tours are getting done this way.
The risk variable for these types of deals becomes more significant in the buyer’s deal calculus, so, correspondingly, these types of transactions are generally reserved for deals in industries where the buyer already has familiarity. With this in mind, companies that are “deal ready” will have a significant advantage. Streamlining the due diligence process has always been an objective, but these days, the correlation between due diligence duration and deal closings has markedly increased. There’s an old saying that “time kills deals,” and that resonates even more today.
In all cases, though, the path of least resistance in today’s M&A environment requires providing a clear understanding of your business fundamentals and economics. With awareness in hand that interactions are likely to be limited, it is essential to bring efficiency to the negotiations. Zoom and email will likely replace roundtable meetings, so being able to provide clarity through company documentation and financials offers a powerful boost toward getting a deal done.
Fortunately, for those among us who are wedded to the “old-fashioned” methods of deal-making, those types of deals will still be out there. These types of interactions are more frequent in introductory situations where there is not prior familiarity between the parties. Nevertheless, deal efficiency will still rule the process, so the importance of limiting hurdles of understanding will still be necessary. Most acquirers with whom we have spoken have established “contact” rules that limit personal interactions.
You Didn’t Come This Far Just to Get This Far
The past few months have been unquestionably difficult and a punch to the gut for most business owners. Sadly, many will suffer irreparable damage. Those who make it through to the other side will, hopefully, be able to build on the strengths they exercised in successfully navigating the crippling effects of the pandemic crisis. And for those of you ready to sell, we hope we made the case in this article that there can be a rainbow and a pot of gold in the current M&A market.
Be ready, though. Fortune will favor the best-prepared businesses when entering the market. Stay true to your business operations and employees. Document and be ready to present pandemic-related effects – both qualitative and quantitative – to prospective buyers. Update your business plan. And assemble a team of trusted advisors who will help you maximize the opportunity that a sale of your business represents. There is still much work to be done, but the good news is: Yes, You Can Still Sell Your Business!