BUYING AND SELLING A COMPANY DURING A PANDEMIC
The pandemic disrupted many aspects of business across Canada, including buying and selling companies. In the second quarter of 2020, deal activity across North America. dropped off a cliff from an already record low first quarter of 2020 caused by the uncertainties of the pandemic. When governments mandated and shut down a large part of the economy in March 2020, many transactions already in-market or under Letter of Intent were abandoned altogether or delayed.
After an initial overall drop-in deal activity, there were signs of an uptick by the end of the summer. Privately owned companies that have fared well during the first wave and were deemed essential have been and continue to be the most targeted for acquisition by strategic buyers looking to add on to their business prospects or as platforms for financial buyers once their existing portfolio companies were no longer under perceived or actual economic threat and the investment fund managers continued to have excess capital to deploy. While there are positive signs of increased deal transactions, the pandemic has changed the way those deals are being done.
Doing deals in this current environment presents some unique challenges. One of the biggest negotiation points in any deal is the valuation of the company being bought. The Pandemic has created uncertainty and disruptions to many businesses that make the valuation of those businesses more difficult. Companies need to make sure they analyze their financial statements and have a great understanding of how the pandemic affected their profits and losses, inventory levels, end demand for their product, and their suppliers ongoing ability to deliver in a timely and predictable fashion and at prices as in their past due to current and potential ongoing supply chain disruptions.
A buyer will engage in due diligence to understand the operations of a company, but due to the pandemic, this analysis and process can take much longer and be more in-depth. When valuation gaps emerge, buyers and sellers need to bridge that gap. The most typical way to do so is by negotiating contingent payments or consideration based on certain milestones (usually financial) being achieved by the selling company. This process, often called an “earnout,” can make deals more complicated and longer to close. Earnouts are quite common in today’s market due to valuations being at odds more frequently due to the pandemic.
A new aspect to deals due to the pandemic are the stimulus programs enacted by the government. Creating new loan liabilities and potential loan forgiveness or grants that did not exist before the pandemic. Many companies have outstanding loans that will have to be addressed in the acquisition process. If loans have not been forgiven, then the purchase documents will have to deal with these outstanding loans.
The most common way that transactions are addressing loans is through an escrow arrangement with the lending bank. The seller will place the amount of loans received into an escrow account with the bank that made the loan. If the loans are forgiven, the bank releases the money back to seller. If the loans are not forgiven for any reason, the bank keeps the amount that was not forgiven. Because this escrow process introduces the bank as a party into your deal, it can create timing delays and more complications. When thinking about selling your company and if you have such a loan, advanced preparation and having a relationship with your bank can be helpful.
We believe deal flow will continue to increase across north America for the many years. Given that Baby Boomers who are the owners, operators, and executives of more than eight hundred thousand Canadian companies are succeeded by a younger generation of entrepreneurs and executives. Being prepared to do a deal is key to a more efficient acquisition process. Understanding that the pandemic will increase due diligence, create valuation gaps, and introduce new concepts — like government loans/grants — into the transaction documents will give you an advantage in a successful deal.
So, how prepared are you for your eventual sale? And What do you this your business worth? Download our Business Valuation Guide and preliminary Checklist to learn more about preparing your business for sale.
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