The COVID-19 pandemic has put all of us into this environment of uncertainty that moving forward often feels like walking with eyes closed. In this episode, Domenic Rinaldi goes solo to help us make sense of what is happening now in the M&A marketplace. He answers whether or not deals are happening and how they have changed during this period of time and likely in the future after COVID. Domenic provides some great key things to think of before doing a deal, no matter if you’re a buyer or a seller. Tune into today’s show as you learn how to face the uncertainty and navigate this environment well. 

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Navigating The Changes In The M&A Marketplace During COVID

I’m going to be talking to you about two things. One, what is the state of the M&A marketplace and how deals changed during this period of time, during COVID, and likely post-COVID. I’ve been incubating this show for a while now. I’ve been receiving a ton of calls and emails from clients and prospective clients wanting to understand what’s happening in the marketplace. Are deals happening? If so, have multiples changed? I wanted to wait until we had the election behind us. We had some concrete information about where things might head especially from a tax perspective. We have more clarity now as I sit here in the middle of November 2020. It looks like the Democrats have gotten the White House, and it’s likely that the Republicans will win the Senate races that are still to be the runoffs that are going to happen in Georgia. If that happens, some of the tax changes that have been proposed are unlikely to happen.

If there are changes, they will probably be much more muted than what had been planned, which holds very well for M&A activity. I’m going to get into what’s happened in the marketplace from our vantage point in 2020 and what we see for 2021. Buyers and sellers, you need to be thinking about and contemplating as you’re looking at doing deals because the landscape has changed. There are things that you need to take into consideration as you move forward and look to do deals.

Before we get into this episode, if you want to avoid the common deal pitfalls and the risk of losing substantial dollars, you need to know how ready you are to buy a business. I believe proper preparation is so critical to deal success. We have published several free resources to help you be better prepared. You can access these resources on our website at K2Adviser.com/resources. Being prepared is critical to ensuring that you maximize revenues and minimize risks. Thank you for being here and I hope you enjoy this episode.

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State Of The M&A Marketplace

As I had teased in the intro, I want to talk about why the marketplace continues to be robust for mergers and acquisitions despite what’s happening around us with the pandemic. One of the clear indications that I’ll point to if we look in our firm, our firm happens to be a larger M&A firm. We do a lot of deals on an annual basis across a broad range of industries. One of the things that I can point to is the pure buyer activity that’s taking place. If we look at activity right now, the number of buyers that we’re working with to help find a suitable business for has substantially increased over the same period in 2019. With that many buyers in the marketplace, you’re sure to have a good and healthy flow of deals. Whether it’s healthy deals or distressed deals, you’re going to have a good healthy flow.

I predict that now that the election is behind us and some of the tax changes will not happen, or they will be much more muted that this level of activity will continue into 2021. Why does it stay robust? First, you have the cost of capital. The cost of capital is low. Interest rates are at historically low levels. It’s cheap for buyers to go out and secure loans to make acquisitions. Lenders have stayed very active. The capital markets are wide open. Lenders while being more cautious and wanting to look at deals more carefully are not shying away at all from acquisition loans. You combine low-interest rates with the capital markets being wide open, and the number of buyers in the marketplace being up substantially makes for a robust M&A marketplace.

We have to have a good number of healthy deals on the other side, healthy businesses to be acquired, but at least the buyer activity has remained very strong. On top of that, you have all of the private equity groups and the amount of money that was raised prior to COVID that is still sitting out there on the sidelines waiting to be deployed. You have all that money sitting in the coffers of private equity groups, strategic companies who have done well holding on to the cash on their balance sheets. Everybody is poised to do deals if they can find the right ones. The two most active buyers in the marketplace right now appear to be strategics companies who were looking to grow through acquisition, and small investor groups or high net worth individuals who’ve been dislocated and looking to go out to do transactions. I mentioned earlier that there is a shortage of good businesses. It’s a tale of haves and has not when you’re looking at business opportunities.

You have companies that have done incredibly well during the pandemic. We’re seeing businesses who are experiencing 200%, 300%, 400% increases in their revenues because they happened to be at the right place at the right time. Unfortunately, we’re seeing the opposite end of that coin where there are businesses that are struggling to stay afloat. As a vaccine gets introduced and things can get back to normal, we’ll start to see some of those businesses recover and get back to some level of normalcy. If that happens, when you combine that with the number of buyers that are in the marketplace with healthy or recovering businesses, as long as interest rates stay low, which it seems like they clearly will, the capital markets remain open, we’ll have a robust mergers and acquisitions environment going into 2021 and maybe even well beyond that.

M&A Marketplace Changes: The two most active buyers in the marketplace right now appear to be strategic companies who were looking to grow through acquisition and small investor groups or high net worth individuals who’ve been dislocated and looking to go out to do transactions.

My advice if you’re a buyer is that you have a couple of things in place, have a plan. Before you get to the marketplace, understand what you’re looking for. What are your key criteria? What would move the needle for you? Assemble a team ahead of time. Not just any team, you need to make sure that you have people by your side who are specialized in mergers and acquisitions, an attorney, accountant, M&A advisor, consultants, whoever it is. Make sure that they have substantial mergers and acquisitions experience. When I get to the next topic, which is how you’re looking at deals, you’re going to need that experience probably now more than ever.

Have your debt and your equity source. With many buyers chasing a few deals, if you get into a deal and you don’t have some of those things already accounted for, and you’re scrambling to figure out your debt and your equity, you could very well lose that opportunity. We saw that happen with a client where they didn’t move fast enough. Sure enough, the seller had a number of parties coming after them. The seller abandoned our buyer and went to the next seller because our buyer wasn’t prepared to move quickly enough. It was too bad because it was a great opportunity.

I am famous for saying, “You need to move faster than deals.” I’m changing that to you need to be efficient. You need to be very careful with what’s going on. Even with a healthy company, you need to dive in and figure out, what are the future prospects? They might be very healthy because they’re a benefactor of what’s happened with COVID. If we get to a post-COVID environment, what’s going to happen? What’s going to settle in? Understanding the post-COVID environment, both for healthy and unhealthy companies is going to be important. You still need to move quickly and efficiently, but be very careful.

Navigating The Changes In The Marketplace

What’s changed? How should you be looking at deals differently than maybe you were looking at them before? Some things have clearly changed in how we can even visit deals, look under the covers, and taking tours. First and foremost is looking at your COVID financial analysis. If you have a healthy company that’s experiencing tremendous growth as a result of what’s going on, you need to understand what’s going to happen after we get through this period of time. Have they reached a new level for their company or are things likely to settle back down? If so, where are they going to settle back down to? You have to be careful not to overpay for what’s happened. You might have businesses who have been impacted negatively by COVID, but still have very good strong foundations and will bounce back or already showing signs of bouncing back. Doing that analysis and understanding where that business might get back to once things settled down will be important.

You’ll need to have the right team of advisors around you to make sure that you’re looking at things properly. Making proper decisions so that you’re not either overpaying or losing opportunities because you’re underpaying in a situation that you haven’t read the tea leaves appropriately and understand what are the prospects for that business. The next thing is the discovery. In years past, you would get a deal on the table and you would start the dance between the buyer and the seller. You’d go out and meet the owners of a business, take a tour of that business, and start to build up some rapport.

As you can imagine, that’s not happening right now. People don’t want to get together the way they did before. If they are, it’s in a very limited capacity. Building a rapport during deals has become a bit of a challenge and you can’t forego it. You can’t say, “Building rapport is something I can’t do.” You have to do it. It’s important for the buyer and seller to build some rapport and get to know each other. It’s the surest way that a deal will get done because every deal hits a speed bump. When it hits a speed bump, you need to have that foundation to work through with the other party. Without that rapport, chances are that deal is going to die.

You have to work harder, whether that’s Zoom meetings, virtual meetings, FaceTime, whatever it is. Anyway, you can have touchpoints, even if they’re virtual touchpoints so that you’re getting to know each other, and understand what each party sees as a win-win outcome of a transaction. Discovery has to be done differently. Sending teams of people into an office to go through records. Financial is not feasible anymore. It might be in certain situations if you can get in there after hours or on weekends when nobody else is around. There’s no concern that anybody could infect a workforce or any chance of COVID being transferred if that risk exists. Doing discovery through a virtual data room, and is where good M&A advisors, attorneys, and accountants can come in and help. You can do a lot virtually through virtual data rooms and understanding how to leverage that.

Let’s move into the deal structure. You’re going to have to get creative. There’s no doubt about it. If you want to get a deal done, whether you’re a buyer looking at a dealer or a seller trying to get something done if your business is doing well or it’s been impacted negatively, there are ways to do these deals, both of them, but you need to be flexible. You need to understand that nobody wants to underpay and nobody wants to steal a business out from somebody. There’s got to be some common ground that allows for flexibility should things not quite turn out the way everybody had hoped.

For owners, maybe a willingness to give the buyers some downside protection. If you’ve been one of those businesses that have experienced tremendous upside, and maybe the upside is here to stay for your business. That’s great. If it’s not and it’s not close to what’s happened historically, maybe there’s some accommodation where you can address any potential future gap. Buyers, if you’ve got a business that has been negatively impacted and it looks like the prospects for that business to bounce back are good, maybe there’s a way to bridge the gap for the seller so that they can realize that rebound.

If it happens in a reasonable period of time, the business hasn’t been completely undervalued. Otherwise, sellers are likely to sit on the sidelines if they can. If they’ve got the capital to do that, they’re going to sit on the sidelines and wait for it to rebound themselves, and realize a full value on the other side. There are ways to bridge these gaps. Any attorney that you speak to now has said they’re challenged with some of these ways. They’re things like performance notes. If a business continues to perform at high levels, no problem. There are payouts at those levels. If it’s a business that’s underperforming and it’s likely to come back, and it does come back, those performance notes can kick in. You can also do it in the form of an earn-out so that you identify future payments tied to certain milestones. Those milestones could be any number of things. It could be revenue. It could be client retention. It could be employee retention. It depends on what’s important in that transaction. Whatever is important, you can build and earn-out a contingent note or a performance note into the deal structure.

M&A Marketplace Changes: It’s so important for the buyer and seller to build some rapport and get to know each other. It’s the surest way that a deal will get done.

What I’ll tell you and any good attorney will tell you is that some of these structures are fraught with potential lawsuits down the road. They have to be carefully crafted. You need professionals to craft them. People, do it all the time so they can think through for you what are the right triggers? How do you keep yourself out of trouble in the future? The last thing you want is a lawsuit a year or two years later after a transaction is done because there’s a misunderstanding about how the performance note should have worked, the earn-out should have worked, whatever it is.

The other thing in a deal that you need to start to accommodate for is reps and warranties. In this COVID environment and post-COVID environment, reps and warranties are being taken to a whole new level. Things that we hadn’t thought about before, risks, future pandemics, whatever it is, things that maybe are unknown to the parties, but need to be accommodated for in the reps and warranties. I can’t stress enough how important it is to have good legal counsel that can represent you, somebody that does it day in and day out. If you don’t have a good attorney, if you don’t have an M&A attorney, please call me or call our firm. We’re happy to refer you. We have dozens and dozens of tremendous M&A attorneys that we can refer you to.

We’re going to talk a little bit about diligence. When you’re looking at a firm now, you have to look at it through a slightly different lens. You’re not only looking at it from the lens of what’s happened in the past but will the business continue to operate in the future for things that may be unknown at the moment? What are the cyber protections in that business? Does the business have IT redundancy? How is it handling remote work capabilities and virtual employees? Does it have the infrastructure in place or at least the foundation that you can take to the next level? Did the previous owners build business continuity plans? If there are no minor or major disruptions, everybody understands how they’d operate in that scenario and what they would do.

Your business interruption insurance is going to come into play big time. More and more people are going to be looking at that insurance as a safety net should the unforeseen happen. Understanding how the business operates for some of these things and diligence is going to be important as you build your planning and your transition plan taking over. There are consultants that specialize in transition and integration planning. They are already modifying their diligence templates to accommodate for some of this and things that you need to be thinking about.

Episode Recap And Reminders

I’m going to recap with a couple of things. I believe that the M&A market is going to continue to be very robust. We’re going to see a healthy number of transactions continue to happen in 2021 and beyond. The capital markets stay open, interest rates stay low, businesses start to rebound. Growing through acquisition is one of the best ways to grow. If you’re trying to acquire your first business, acquiring versus starting is a much safer bet to getting into a business. The road ahead is going to be very strong for M&A. I know for our firm, we’ve experienced a record year in 2020. It’s the best year ever by a long shot. In the middle of all of this craziness, the future prospects look tremendous.

Let me end with a couple of reminders. One, have a plan in place. Build your plan, whether you’re a buyer or a seller. If you’re a seller, put all the pieces in place well before you’re ready to go to market. If you’re a buyer, put all your acquisition pieces in place, have your plans settled, know what you’re looking for, what your criteria are before you launch a search. Assemble the team, put a mergers and acquisitions team by your side. People that will have your back throughout the process and people who are not afraid to speak their opinion. If they see that something isn’t right, they’re willing to guide you in a different direction. If they see that the deal can be done and obstacles can be overcome, they’re going to offer up tremendous advice and help you get the deal done.

Have your debt and your equity source. Understand where your equity is coming from and how you can secure debt. There are plenty of ways to do that. If you don’t know how to do it, call us. We’re happy to walk you through that. You’re going to have to work very efficiently. Speed matters, but you have to be cautious. I used to say purely you have to move fast. I’m changing that so you have to move very efficiently. You still need to get through the process as quickly as you can, but as thoughtful and thorough as you possibly can. I hope you enjoyed this episode. If you enjoy our content, please remember to subscribe and review our podcast. I look forward to seeing you again in the next episode. Until then, please remember that scaling, acquiring, or selling a business takes time, preparation, and proper knowledge.

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