Mergers and Acquisitions Continue, But Deal Structures Reflect COVID-19 Stress

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Buying or Selling Now Requires Flexibility

By Curtis Dean, CPA, MST, CGMA and Ryan Scheck, CPA, ABV

One corner of the economy that has managed to continue operating during the COVID-19 crisis is the merger and acquisition market. There has been little slowdown in Kansas deal making since the economy slowed to a crawl in March. But deals that began before the business shutdown have frequently seen price adjustments prior to closing. Amid continuing economic uncertainty, in many instances a greater portion of the sale price has been shifted to earnout with a discount to the initial payout.

It is a way for buyers to build in safeguards in an economic environment that makes it hard to project what cash flows will look like in the future.

 

Deal Structures Changing

While shifting a larger portion of the sale price to the earnout creates a safety net for buyers; for sellers it induces anxiety over whether the buyer will continue operating the business in the best way to maximize the earnout. At a time of economic uncertainty – like now – deal structure issues become the biggest negotiation after the price.

The economic downturn due to COVID-19 has, essentially, diminished flexibility that formerly existed in the merger and acquisition market. Sellers who need or want to sell quickly must be more flexible on price and deal structure.

Valuation Issues

The COVID-19 crisis has complicated valuations in some industries more than others. An example would be the restaurant industry, which has been among the hardest hit by coronavirus-related closures. A financially pressured owner who was anxious to sell during the height of the shutdown this spring learned that at that time, the value of his restaurant was limited to its liquidation value. Typically, a restaurant would be valued using a combination of income, capitalization, and projected future earnings. Eager to sell, the owner agreed to an asset sale.

Buying or Selling Now

Despite the COVID-19 impact and the uncertainty of the current economic downturn, the same principles that have always applied to buying and selling businesses still apply now:

  • Tax consequences: The tax consequences of a business sale or acquisition will likely drive many of the decisions around the deal structure. Will it be an asset sale or a stock sale? Are there multiple entities involved? How will the sale price be split between an initial payout and earnout? All these questions have tax impacts that must be weighed against each other.
  • Entity structure: A recent deal sought by a small business involved a real estate partnership with the operating business held inside a C Corporation. The buyer wanted it all as one package but putting together the deal in a tax-efficient way was a challenge. The buyer and seller ultimately agreed to split the price between the two entities. Though negotiations began earlier, the deal closed after the COVID-19 shutdown began. It didn’t affect the overall sale price, but the economic uncertainty resulted in a modified split of the price between the entities, which helped the buyer obtain financing.
  • Maximizing valuation: Do you know what your current business valuation is? Even if you’re not looking to sell immediately, getting a benchmark valuation will help you identify which areas of your business need improvement that could boost the valuation down the road when you are ready to sell. Valuation is often tied to current market conditions. You can’t control that. But you can control your balance sheet, the condition of your property and equipment, and your investment in technology systems.

Contact your Adams Brown advisor to discuss any plans you may have to buy or sell a business in the current economic environment.