Jason Varney, partner at law firm Thomson Snell & Passmore
As with most people’s business calls these days, a recent conversation with a client turned to talk of the pandemic…and whilst the economic outlook does look rather bleak, our client asked us an interesting question: “is this a good time to be pursuing M&A?”
Within any bull or bear market there are opportunities available for those willing to seek them out; and the current recession is no exception.
Below are a few of our thoughts in answer to the question of whether it is currently a good time to be seeking to acquire or dispose of a business:
More opportunity
Many businesses would have needed to reconsider their strategy and business plans in light of the pandemic; and as a result, some companies would have decided to narrow their focus and/or build cash reserves. As a consequence, a number of directors will likely seek to divest of non-core assets and subsidiaries to focus on the more profitable elements of their business. Similarly, if cash flow is a concern, a divestment of an asset which is not core to the wider corporate group’s strategy may well provide the group with a much needed “cash” safety net.
Therefore we are likely to see further M&A opportunities entering the market in the not so distant future, which will then allow the divesting companies to focus their attention on profitability and, ultimately, survival.
On the other side of the fence, those businesses that are looking to grow quickly but are struggling to do so organically during the pandemic may see M&A (whether standard, distressed or pre-packed) as a viable route to achieve such growth.
Potential capital gains tax changes
It is rumoured that the Chancellor will seek to reduce the COVID-19 deficit by introducing changes to capital gains tax.
Although we do not yet know what the changes will look like, some shareholders may want to take advantage of the current CGT regime (including entrepreneurs’ relief) by exiting their companies before any of the Chancellor’s changes take effect.
This can provide a clear opportunity for those looking to expand and acquire new businesses given that (i) new assets will enter the market, (ii) M&A timetables will be accelerated and (iii) valuations may become more “realistic” given the need to complete quickly.
Company valuations
I mentioned above that the current market may prompt a change in the approach to company valuations. I recently joined a webinar hosted by a financial advisory firm who mentioned that COVID-19 is having an effect not only on EBITDA multiples, but also on the view of future profits; and with Brexit just around the corner, one can foresee that business owners may have to lower their expectations of what consideration they will likely receive for their shares.
These lower valuations are likely to prompt more interest from investors – and if the valuation is sufficiently low and the asset is particularly attractive, we will likely see more M&A auction processes being set up.
Capital
Following certain recent discussions that I have had with various investors (from venture capital to private equity) and Corporate Finance houses, it is clear that there is still a lot of capital in the UK market. Many of the investment directors who had to reel in their M&A activity at the start of the lockdown are now being told to get back into the market and look for opportunities to invest (which is certainly different to the approach taken during the last recession in 2008).
If you can therefore demonstrate that your business has clear growth potential and a good equity story, it is likely that investors and CF houses will be very keen to set up a “virtual coffee” with you – especially if the business has already survived (or even thrived!) during the first stage of the pandemic.
So, is this a good time to be pursuing M&A?
With more opportunities hitting the market, lower valuations, more investment capital available and the need to consider tax planning, this certainly can be a good time to pursue M&A.
One interesting development we have recently found in the current M&A market – perhaps as a consequence of investors and trade-buyers becoming more cautious than they necessarily would be in a boom market – is the increased eagerness to use earnout consideration structures (being, in summary, additional consideration payable to the business vendors if the company hits certain financial targets over a defined period of time). This eagerness is likely because investors and trade-buyers are perhaps more risk adverse during the pandemic and therefore see it as important that exiting parties participate in the risk.