Will COVID-19 Drive a Wave of M&A for Small Businesses?

COVID-19 is creating ripe opportunities for M&A, according to some financial industry experts. Where once thriving companies are now wondering if they can stay afloat, other businesses find themselves with a sudden influx of cash. 

“We are seeing a lot of companies with converging needs,” says Reece Tomlinson, CEO and founder of RWT Growth, a boutique capital advisory firm headquartered in London. “Healthy companies with a lot of cash see this as an opportunity to acquire companies in distress, while companies in distress need access to liquidity to offload some assets.” These deals can reduce the operational risk that COVID-19 presents for some small businesses, he notes. “When executed properly, they can increase profits or reduce overall operating costs, which leads to higher margins.”

Gary Miller, founder and CEO of GEM Strategy Management, an M&A consulting firm in Denver, agrees. He notes that companies with a lot of excess cash reserves, or “dry powder,” are aggressively looking for companies in distress that have a strong bench of talent and earning potential but are being forced to sell because of the virus. “The valuations from the past aren’t holding, and buyers are hoping to pick up deals,” he says.

Baby boomers may also be eager to sell their companies, rather than trying rebuild after a catastrophic economic downturn, Tomlinson says. “As such, SMEs owned by baby boomers reflect a real opportunity to complete M&A deals.”

This potential is bolstered by access to cheap debt. With interest rates near zero, and numerous government funding options available to help businesses through the pandemic, the ability to access debt for strategic M&A deals “will be profound,” Tomlinson says.

Though this doesn’t mean that sellers have no leverage. While many companies in financial distress will likely have to accept discounted offers for quick sales, others will have stronger bargaining positions. If owners are in need of short-term liquidity, but still have strong balance sheets and solid earning potential, they can secure good valuations, especially if they are willing to accept creative deal structures, such as vendor financing, or earn-out structures, Miller says.

And the good deals won’t stick around for long, adds Ann Hanna, managing director and owner of Taureau Group, a boutique investment bank in Milwaukee. She predicts that Q3 2020 will see a significant uptick in M&A transactions, but that even troubled businesses will start to rebound by the fourth quarter as states reopen for business. “If you are comfortable with a little uncertainty, you can still find deals,” she says, “but you have to make a move soon.”

Finding the Deal

As with any M&A decision, the key is finding the right business to complement your needs, then securing a deal that work for both parties. 

1. Start with low hanging fruit.

Often times the best deals will come from companies in distress or those with owners who just want to get out. Miller suggests looking at companies owned by owners who may be more likely to retire, and that had strong earnings before the pandemic. You can also talk to M&A firms and business brokers, who can offer lists of companies looking for buyers, he says.

2. Look for companies that complement your business.

An acquisition should add some strategic benefit that you can’t easily get on your own. Tomlinson suggests looking for companies that will expand your footprint into a new geography, bring a new product to your portfolio, upgrade your technology, provide access to a desired customer base or eliminate a competitor. “You will be tying up resources in this deal, so it is important that it adds value to the business,” he says.

3. Consider your network.

Chances are you know someone in your community, network or industry who’s ready to sell. So reach out, Tomlinson says. “They may be open to discussions.”

If you are comfortable with a little uncertainty, you can still find deals [...] but you have to make a move soon.

—Ann Hanna, managing director and owner, Taureau Group

4. Study their balance sheets.

Before making an offer, work with your lawyer or accountant to do a deep dive into their operations, studying their balance sheets, current revenues, past financial performance and potential earnings, Hanna says. When projecting future earnings, she suggests treating COVID-19 as more of a natural disaster than a recession. “The markets aren’t broken, like in 2008-09,” she says. “Eventually we will return to our pre-disaster economy.”

5. Consider all your financing options.

Historically you’d need 15-30% of the cost of the acquisition in cash. But with a market full of motivated sellers, you can get creative, Miller says. Some popular models include:

• Vendor take-backs (or vendor/seller financing): In these deals, the seller loans a portion of the purchase price to the buyer to help close the deal. In other words, it means that they agree to be paid at a later date.
• Mezzanine financing: Mezzanine lenders lend money based on a company's ability to repay the debt through cash flow. For the right deal, a mezzanine loan could provide all of the funding needed to complete an acquisition.
• Earn outs: Along with a smaller upfront payment, in these deals, the seller receives additional compensation in the future as the business achieves specific milestones. This reduces risks for buyers who can tie payments to EBITDA goals, and provide the seller with ongoing income.
• Private financing or asset lenders: Traditional banks are being overly cautious during the pandemic but private lenders are still available. Their interest rates may be higher but so is their risk tolerance.

Looking to sell?

Owners of distressed companies who are looking for a lifeboat should keep in mind that these deals won’t close quickly. It can take anywhere between three to nine months or more to find, vet and complete an acquisition, Miller says. And if you can hold out till the economy or your business starts to recover, you may be able to secure a better deal. Before deciding to sell, he urges owners to take advantage of government programs, delayed payment options and loans where possible to keep their business afloat.

Photo: Getty Images

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