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Published 28 May 2020
In this article Clive Garston, consultant, gives his view on what he thinks will happen to M&A in a post COVID-19 world.
The Coronavirus pandemic is casting a giant shadow over the whole world. Business activity is dramatically reduced and insolvencies are increasing, especially in certain sectors. The oil price has collapsed, and the world's attitude to and view of China has changed. What appears to be clear is the world will never be quite the same regardless of whether COVID-19 disappears completely or has a reduced effect. Some sectors will suffer more than others and this has to include businesses that are dependent upon people being able to congregate together, such as food and hospitality, entertainment and events. On the other hand certain sectors will benefit, including pharma, biotech and supermarkets, along with any sector which specialises in working at home, such as meeting applications.
I do expect M&A to continue, but I think the number of transactions, the way in which they are structured and the valuations attained will be different. Companies in a strong financial position will look to be opportunistic, may change their strategy and take advantage of transactions at reduced valuations.
The way in which deals are structured will change. It is always been difficult to value a business as past performance is not necessarily an accurate guide to future performance. The current situation makes this valuation process even more difficult. A seller is likely to argue with a sceptical buyer that business will return to pre-pandemic levels, but this is a speculative and risky assumption from a buyer's point of view. I believe that this will give rise to a resurgence of earn-out based transactions. An earn-out values a business based on future performance and this may be the answer. In simple terms it provides for future payments based on future performance, with the ultimate consideration being capped or unlimited. In principle, this would seem to be an answer to the valuation issue, but earn-outs in themselves create differing problems. A buyer may want to integrate the business, but will be unable to do so because the seller will wish to retain control in order to be able to maximise profitability over the earn-out period. The buyer will want to take a long term view while the seller will only be interested in maximising profitability during the earn-out period. The attraction of an earn-out for a buyer will be the need for less initial cash at a time when acquisition finance may not be easy to source. A seller agreeing to an earn-out will have to be satisfied that the buyer is going to be able to satisfy the earn-out and will have the resources to do so.
The locked-box structure (which is traditionally thought to be more seller friendly) is likely to be less popular as way of valuing a target company, unless it is in an industry that has not been adversely affected by the current pandemic. I think this means that if such an acquisition does not use an earn-out structure there will be a return to the more traditional purchase price adjustment by reference to a completion accounts mechanism.
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