It has been an interesting year for M&A activity; but most surprising has been the speed of recovery of cross-border M&A despite the economic backdrop.
The impact of COVID-19 on international deals in 2020 was initially abrupt. At the outset, the uncertainty of the economy and financial market meant that many deals were put on pause or the plans for anticipated future transactions were aborted. Many of these deals, however, did not stall for long and despite apparent adversity, many international companies and private equity (PE) funds have remained active and resilient throughout.
In the M&A market, deal volumes began to increase around six weeks after COVID-19 restrictions were introduced, as investors returned to the market and sellers wanted cash quickly. By June, deal appetite was back on track. Such a quick bounce may surprise many; but each deal tells its own story.
Corporate partner at Brodies, Will McIntosh, notes that private equity has had a considerable part to play in that bounce (both supply and demand). Private equity funds globally have record levels of money to be invested in buy-outs; and have a continued appetite to do deals. On the supply side, there are a number of mature PE portfolios looking for exits. In addition, companies have been looking to increase their geographic footprint and add product ranges to be sold to existing clients, which has driven consolidation through M&A activity.
But these macro factors do not fully explain the quick M&A revival. If you look in detail, deal structures have had to be re-engineered; new sources of funding have had to be found; and challenges of lock-down addressed.
Lawyers have had to become creative to give comfort to both buyers and sellers in a time of market uncertainty and around issues such as valuation gaps and funding of deals. Historic financial performance has become a questionable yardstick for valuing companies in these uncertain times. Yet, target companies haven't all been adversely affected to the same extent; and certain sectors (particularly tech as well as hygiene) have seen turnover and margins increase. So, considerable scrutiny has gone into ascertaining the short-term economic impacts of COVID as well as anticipated future sustainable earnings; often leading to divergent views between buyers and sellers on earnings and valuations.
There are several ways in which valuation gaps can be bridged, such as mechanisms known as earn-outs. These broadly entail paying additional consideration based on future financial performance – the better the financial results, the more the sellers get paid. Other mechanisms involve the sellers only partially cashing out (e.g. by rolling part of their sales proceeds back into the buyer entity, so as to share in the future performance of the group) or equity-for-equity deals. Creative structuring has helped to ensure that the buyer has the confidence to offer a higher price, even when trading of the target has been impacted, which in turn benefits the seller.
The market uncertainty also had a significant impact on the availability of debt finance for buyers, as traditional lenders become less willing to lend to the same extent. Funding for deals has had to come from alternative sources such as debt funds and deals have had to be restructured. Sellers have also helped plug the funding gaps, by agreeing to deferred payment terms or "vendor loans", in order to ensure the sale completes on preferential terms.
Another challenge arising out of social distancing measures has been carrying out usual due diligence into the target business, in order to fully understand its financial affairs, as well as its operations and inherent risks. Most successful acquisitions rely on getting to grips with the operations and planning for integration, site visits and management meetings. Yet both diligence and subsequent integration have had to be largely reinvented, with tech and electronic signatures playing a part.
As a result of these factors some deals perhaps took longer to get to the finish line, but a slightly extended timetable has not stopped them from completing.
A good example is Kersia Group – a private-equity backed French company, which grew through M&A to become Europe’s second largest food safety company – including completing the acquisition of UK-based Holchem.
Alban Houssin, Kersia M&A manager said: " Decision-makers not being allowed to travel especially for first contacts was a real added complexity, but we successfully adapted our acquisition processes to lockdown constraints notably with a wide use of technology video calls, higher support from external local advisors for operational diligences (usually managed by HQ) and of course electronic signatures. Our integration playbook has also been updated accordingly with new software solutions enabling seamless remote Post Merger Integration process.
Resilience of our food end-markets have been key to complete such acquisitions during the pandemic. Covid-19 has strengthened hygiene protocols to the food safety market with long-term positive market tailwinds and we are definitely pursuing our acquisition strategy."
COVID-19 will continue to have a material global impact. Despite negative forecasting and market uncertainty, companies and PE funds have remained resilient and continued to complete cross-border transactions throughout the pandemic. Buyers and investors who are able to plan strategically and think creatively will overcome any M&A hurdles and will be the ones who succeed in taking advantage of the current financial market.