The early months of 2020 have seen dramatic business disruptions due to the outbreak of COVID-19 and the efforts to contain its spread. These disruptions have caused economic turmoil, and muddied the waters around proposed or pending merger and acquisition (M&A) transactions. Over the next few weeks, CGK Business Sales will take a look at the potential impact of COVID-19 on M&A. The first topic to consider will be business valuation – what is the impact of the coronavirus on how much my business is worth?
Before the COVID-19 pandemic, business valuations were reaching all-time highs. With the volatile shift that has taken place since then, it may be difficult to line up valuation expectations between buyers and sellers. When there is a gap in valuation, there are a number of tools to bridge the gap, but in light of the COVID-19 pandemic, each has new risks.
An “earnout” is simply a pricing structure where the seller must “earn” part of the purchase price based on the performance of the business following the acquisition. It’s a way of protecting the buyer from downside risk, but also getting the seller a full value if the business performs in line with expectations. However, depending on the business and industry, it may be harder than ever to predict what those expectations are in the next few months and even years. Using non-financial milestones may be a solution, or using financial milestones with more flexible time limits to allow more time for a business to find its feet. Additionally, sellers may want even more specific promises of how the business will be run in the future to protect their earnouts. With more and more businesses facing layoffs and radical changes, the need for these protections would be particularly helpful.
Many businesses are trying to limit their use of cash until operations return to some semblance of “normal.” The use of buyer stock in lieu of cash can be attractive, but again, there are risks involved. The parties will need to agree on a share valuation method (fixed, floating, or hybrid) that works for both sides. In a volatile market environment, that can be quite difficult. Sellers will also need to be fully confident in the ability of the buyers to grow the business to make this arrangement attractive.
Purchase Price Adjustments
Price adjustments are usually structured to compensate the appropriate party if financial measures (most commonly the target’s working capital) deviate from a “normal” level at closing. However in the current environment, determining “normal” is not going to be easy. Some parties may want to ignore the COVID-19 situation as an outlier, and expect the business to return to its usual numbers in short order. Others will anticipate longer, systemic changes that will have a material effect on the value of the company. To bridge this gap, M&A advisors can help both sides by using seasonal averages, longer-term data trends, or even limits on how much the purchase price can be affected.
Business sales during the COVID-19 pandemic are definitely in uncharted waters. However an experienced business broker like CGK Business Sales Washington DC (or any of our offices nationwide) can help you navigate and succeed, even during the current crisis. Contact us today to start your confidential, no-strings conversation.