Since the financial market meltdown, merger and acquisition activity has tumbled off the once-sacred cliffs of deal-making.
Private company merger and acquisition transactions are down 58 percent year-over-year, as shown in the Alliance of Merger & Acquisition Advisors survey results.
But astute buyers can use this down market to their advantage, because some of the negatives can be turned to advantages.
Multiples are down for sellers, so they’re more willing to negotiate.
And competition is lighter, because not as many buyers can get financing.
Mergers and acquisitions of venture-backed companies were down 56 percent during the third quarter, year-over-year, according to Dow Jones VentureSource — which is consistent with pre-boom numbers of 1999.
“The most obvious reason to buy now is that values are depressed,” said Austin Buckett, manager, BiggsKofford P.C., during an Entrepreneurial Corner at the accounting firm. “Private businesses have devalued significantly in the last 18 months or so.”
Even for a healthy business, organic growth is difficult during a down market. Businesses aren’t attracting new customers, and current customers aren’t ordering more.
When a business has reduced volume, the opportunity for acquisition is better, and/or it can be easier to integrate two companies after a merger or acquisition.
Many people in the industry think this is the beginning of an acquisition cycle which might last two years or so, said Chris Blees, CEO of BiggsKofford.
Some companies might not quite have hit bottom, so owners are not yet ready to lower their values.
But this is the time to “plant the seed” and approach a company.
“When they finally get to the threshold of pain,” Blees said, they’ll be willing to be acquired at multiples of two to three times earnings before interest, taxes, depreciation and amortization, instead of five to six times EBITDA.
Opportunity, of course, depends on sellers’ expectations.
During a strong market, sellers were demanding that less due diligence be done, to expedite the process and spare the effort of providing as much information for the data room, virtual or otherwise.
But in a weak market, “We’re seeing more and more due diligence being done,” Buckett said. “You have a lot more time to get the deal done.”
On the downside, the seller might have more debt than a buyer is willing to assume, and in a down economy, a buyer doesn’t know if a particular business has reached bottom, yet.
Nate Ford, head of Faegre & Benson’s mergers and acquisitions practice in Colorado and a partner in the firm’s Denver office, said that while there are not a lot of M&A deals closing, there has been a recent uptick in activity — particularly with strategic deals.
But there continues to be a valuation gap between what sellers who are not distressed want, and what buyers want to offer.
Buyers are asking to share some of the risk with sellers. Thus, many deals have contingent payment structures, such as earn-outs (in which a seller receives additional payment based on future earnings).
“There’s a lot of tension in the market,” Ford said. “A substantial minority of transactions that make it to the letter-of-intent stage actually get closed.”
But humans can adapt to most anything, and deal structures are evolving in response to market conditions.
In the current environment, buyers need to be flexible and creative.
The macro trend is toward structures that are strategic, rather than financial.
When looking for potential companies, buyers should first look at competitors and try to identify under-performance in a company — but it needs to be a problem the buyer can solve.
The next step is to determine whether integrating the company with an existing company is viable.
“In spite of blatant financial synergies, (it’s important to know if) the cultures are so far off that integration would be just beating your head against a wall,” Blees said. “You’ll have to dig deep and get comfortable with your assessment of this company.”
Remember the adage that past performance is not an indicator of future performance.
And if the seller is trying to rush the deal, “it’s a red flag,” Buckett said.
“Unless there’s a compelling value,” — such as covering payroll in exchange for buying the business, which is not unheard of in this market — “then don’t rush the deal without due diligence,” Buckett said.
The two main purposes of due diligence are to vet whether it’s a good deal and to identify all of the synergies, integration steps and next steps to take after the purchase.
Other than low valuations, one of the main reasons to buy in a down market is to integrate two companies and emerge stronger during the economic recovery, while other companies are still struggling.
And key employees need to be part of due diligence before the acquisition — because they will be the ones guiding the successful integration.
“This is a nonfinancial consideration that is critical to your success,” Buckett said. Buyers need to know whether the management teams of both companies can work together.
Business owners should conduct a strategic analysis of their own companies first — before buying/acquiring another company — to determine their own strengths and weaknesses.
“Then you know what to look for when embarking on an acquisition strategy,” Blees said.
If an owner has taken the initiative to do a strategic analysis, then when a distressed company approaches him or her — they’ll know an opportunity when it arises and be prepared.
And there will be “many opportunities” during the next 12 to 18 months.
All such occasions are well and good, but reality is that financing is still difficult to obtain.
“The fact is, there’s a disconnect between lenders who say they’re lending, and what the underwriters say when someone actually applies for a loan,” Blees said.
Currently, the “message” is that there are no capital/cash flow loans, but there are asset loans, with required collateral.
“And we’re seeing earn-outs in every transaction in the last 12 months,” he said. “Earn-outs used to be thrown in as bonuses — value kickers. Today, earn-outs are part of the package.”
The good news in this economic environment is that there are “no rules,” Blees said.
“The bad news is it’s an education process — for buyers and lenders. Financing opportunities exist in renegotiation of contracts and loans, not with traditional lenders.
“Clearly, the economic outlook is brighter, and there’s a high amount of cash being held,” Ford said. “So we’re optimistic there may be a return to more deal activity.”
According to the AMAA, there’s plenty of money on the sidelines — a $400 billion overhang of capital built up in private equity groups, which ought to help the market during 2010.
“One day, the frothiness will return and we’ll be selling for huge multiples again, and people and banks will get stupid again,” Blees said. “But until then — we have to be strategic.”