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 have been disrupted; and oil prices are bouncing around at all-time.
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 lockdowns 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 because 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.
- 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.
- 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 nonbinding 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.
- 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.
Is there any good news during the current pandemic environment?
Yes. Many buyers are cash rich 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.
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. Contact him at 303-409-7740 or gmiller@gemstrategymanagement.com.
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