M&A During COVID-19 Times

We are living in very uncertain times — nothing that any of us have experienced in our lifetimes. While many of you may have lived through some more recent downturns, this current situation is unique; it is unclear as to when and how we will emerge from the current pandemic. Some industries are being devastated in the short term, while others are experiencing a significant uptick in activity. One thing is certain, when we emerge to something approaching the “new normal”, much of what we have historically considered as best practices and standard behavior will have changed.

The purpose of this blog is to provide insights into buy/sell considerations for Boards and management teams. I will divide the post into two separate blocks: 1) Considerations for Buy Side Activity and 2) Considerations for Sell Side Activity, often due to inbound interest.

Buy Side Activity

For companies that are currently engaged in buy side activity or considering acquiring a company, here are some thoughts that I would take into consideration.

Stay Calm; Valuations are unsteady and will likely go down over the next quarter or two days.

1. Valuations were frothy prior to COVID-19 and sellers will need some time for the new reality to set in and adjust their expectations. And like we discussed in the “weathering the storm” document, your focus should remain on reforecasting on a monthly basis to sharpen competitive intelligence. This is a perfect time to continue to develop your market analysis and ecosystem mapping of your competition and target landscape. This work will pay dividends later in the cycle and keeps the organization up to date to the changing landscape.
2. In most cases, I would put acquisitions on hold for a period of time to really understand where valuations are going and to truly ascertain the impact it will have on the target. Work instead on developing your internal M&A tools: Integration Plan, Due Diligence Checklist for pre and post LOI, Merger Modelling etc.
3. If you have a too good to miss opportunity — go for a longer exclusivity period. Consider locking in the potential targets with a longer exclusivity period so that you can see first-hand the impact to their results and forecasts. The normal time period for exclusivity is between 30 and 45 days. In the current environment, it would not be unusual to request 90 days or even 120 days.
4. Also explore if you can acquire assets instead of shares? Normally sellers will want to sell shares but in many cases today you may be able to carve out the specific assets you want rather than the whole company. This will reduce integration risk, due diligence effort and purchase price while also providing enhanced tax benefits to the buyer.

Areas to focus on? Selected high value/low risk assets and relationships.

If we suggest caution for company acquisitions, we also recommend a proactive stance for selected high value assets.

1. Aqui-hires. Review organizational headcount requirements and in the event that a “Super Star” becomes available in an area of need, be in a position to take advantage of it to fill an executive hole. Also in some cases, valuable teams may be acquired just for their salaries, and fill a strategic hole quickly.
2. IP acquisitions. IP acquisitions may be available at valuations that are significantly below market and diligence can be completed remotely.
3. The best transactions are often completed with a seller that already has an existing trust/respect based relationship with a potential buyer. Not only these contacts provide great intelligence, but they also improve the odds of success.

Please nota bene! If you don’t have a track record/M&A culture — this is NOT a good time to begin, no matter how tempting this might be.

I would recommend that only companies that have already executed on a previous transaction or that have a management team that have completed acquisitions with a prior company attempt to move forward with a full acquisition as the skills you have developed will be essential to integrate the target effectively. Here are a number of additional risks in this environment:

1. Due diligence will be much trickier as the bulk of it may have to be completed using Zoom or the like. My experience is that there is nothing to compare to a face to face meeting and facility tour to get a real sense of the company and you will likely not have that luxury in this environment. Some of the work can be offloaded to organizations that perform this work albeit at an additional cost but it is a key consideration to keep your team safe but at the same time to complete the necessary diligence work.
2. Geography will continue to play a significant factor in execution risk. The further the geographic distance, the higher the risk. Focusing on potential transactions that are in closer proximity to the headquarters will reduce the overall risk profile.
3. Be especially wary of taking on additional burn unless your current cash position can justify it. Prepare and forecast for an integration that executes at a lower range of expectations. In other words, be very conservative in your modeling.

Sell Side Activity

Most acquisitions will be put on hold, in particular for companies that continue to burn cash or who have not reached a reasonable scale. Strategic acquisitions will continue, albeit at valuations that are lower than what we were experiencing less than 90 days ago. Strategic buyers will be concerned with their own market position, private equity players will have less ability to fund a portion of the purchase price with debt and investors will be much more prudent in additional funding for either new or existing portfolio companies. This will significantly impact the market opportunity for sell side transactions in the short to medium term.

If the past is any predictor of the future, when the market turns — and it will — the acquisition activity will return as well, but I believe it will be somewhat cautious at first. Once the first few transactions are announced, at frenzy could occur as larger buyers attempt to build strategic advantages in the market. As a result of these points, I would offer the following thoughts to management teams and Boards who are contemplating a sale.

Your Job 1 is to prepare the ground for you to negotiate from a position of strength.

1. Ensure you have sufficient runway to last late into 2021. If you were fortunate enough to complete a raise recently that is fantastic news but for those that haven’t you need to figure out how to extend your runway. If you have the ability to raise capital I would take advantage of it provided the terms are not ridiculous. Almost all companies are examining their cost structure and taking aggressive action to reduce headcount to mirror revised forecasts. The cuts are painful but the reality is that today your survival is at stake. My experience is that the best action is one that is a little deeper so that you don’t need to do a second cut shortly thereafter. It also provides management with an opportunity to eliminate some underperformers as part of the overall reduction in force.
2. Meanwhile, ensure you are finding ways to get all your staff engaged both at a departmental level as well as creating activities that are social in nature to maintain morale.
3. If you have not already hired an M&A firm, I am in favor of reaching out to a limited number of investment banks to get a sense of their feelings about your marketplace and some potential ideas they have. This is done under the auspices of just getting to know them so that in the future you can move quickly to select the best firm to represent your organization. Do not sign any engagement letters but rather capture and compare the knowledge they have and whether you could work closely with one of them when the timing is right.

Continue to enhance your position and relationships in the ecosystem you operate within.

1. Just as discussed above on the buy side section, I cannot emphasize this enough as the best transactions are completed with a buyer that already has an existing relationship with a target prior to the actual acquisition. Make this a formal part of your management meetings to discuss your market and what is occurring and the impact to your organization so that you can identify the parties to whom it’s worth reaching out. This is not a static list as there will continue to be changes in the short and medium term to this list.
2. Update your web site and any social media sites. Remember, in many cases the first place a potential buyer looks is your web site and often if not up to date you can inadvertently be sending incorrect positioning statements.
3. Do you have an existing research relationship? Is your market included in existing research? Remember that very often the largest buyers use these firms to identify gaps in their technology road map so make sure you are engaged in an effort to enhance their knowledge of your market position and differentiation. As part of this, management should reexamine your technology road map. It is essential that you are working only on priorities that will enhance your position.

Be ready to pounce into action at any time. This can be achieved through the following:

1. Continue to maintain your electronic data room up to date so that you are prepared if and when the market turns. A coordinated, organized complete data room provides confidence to potential acquirers and investors.
2. This is also a good time to review areas that can cause due diligence problems in the future. Consider performing a code scan, review all employee files to ensure everyone has executed non-competes and IP assignment agreements.
3. Communicate constantly with your stakeholders. In this type of environment everyone prefers a management team that is keeping them up to date. I would consider increasing the cadence of Board meetings to monthly so that no one is caught off guard by sudden changes and opportunities that avail themselves.

As I stated at the beginning, and as you all know — we are in wildly uncertain times. As I write this blog, many countries, states and provinces are examining an easing of their restrictions. While these are clearly difficult times, there will be many new opportunities created in places where the pandemic has exposed underlying cracks. I hope these thoughts were helpful to you. If you have any questions, please do not hesitate to reach out to me directly at scott@inovia.vc.