Based upon conversations I’ve had with my clients who were in the process of selling, or considering selling their company, I’ve laid out five scenarios in which things may have changed due to the COVID-19 pandemic, and how we can prepare for the environment in which we now live.
Is it a buyer’s or seller’s market?
Since 2010, the buyers of businesses, including competitors, private equity and family offices, have been willing to pay a premium for businesses. We will still have cheap money, but businesses are more likely to shore up their balance sheet before going out and making any acquisitions.
Buyers have not left the market completely; they seem to have asked for a “pause” to understand what the next couple of months have in store. We are still receiving offers for businesses we represent, but the terms and details are more time dependent and beneficial to the buyer. A bigger percentage of the total consideration has moved towards self- financing and an “earn out,” with cash taking the hit. This provides more certainty for the buyer and insurance the acquiring firm continues to produce at negotiated levels.
Private equity is always going to have to deploy investor capital, and therefore deals are going to get done — but at what price remains to be seen. In response to the current situation, banks are going to be more stringent with lending. They will ask for higher covenants than they have in the past. The underwriting will be slower and more restrictive. The debt ratios will certainly not be as aggressive as they once were, and the bank will ask for more liquidity.
What you can do: We always advise clients they should to be prepared to sell their business in six months. Business owners should review and update their financial forecasting to show how they will be impacted by COVID-19. In order to differentiate yourself, a business owner should be able to answer how they responded to COVID-19, and how they would prepare for a similar pandemic in the future.
The due diligence process will change
Once a buyer and seller have agreed to the price and certain terms and agreements, the due diligence process starts. This includes a deep dive into your financials, employees, computer systems and technologies, hard and soft assets, etc. In the future, due diligence will include pandemic-based continuity planning, such as:
- Does your company have a business continuity plan? Have your financials been stress tested?
- How long can you sustain a certain level of underperformance? Can your employees work remotely?
- What technologies do you have in place to shore up a seamless transition?
- Do you have teleconference technology that everyone understands how to use?
- Is the technology that you use secure, and not able to be hacked?
- Do you have business interruption insurance, or do you have self-funded cash reserves for a three, six and nine month period?
What you can do: Be prepared now to go through a due diligence process. This is also a time to look at your corporate succession plan, as this pandemic has caused us all to reflect and understand what we previously thought was not a reality can become a reality fairly quickly.
Buyers will be even more concerned with plans if you, the business owner, are not at the helm. Prepare the next management team to understand the roles and responsibilities they will play if you are not in the picture.
Review your plan. Have an outside group review your plan, review with your board of directors or create a board to help provide guidance. Create incentive plans for your key employees who have helped you through this current situation and have been strong contributors in the past. Consider having an outside firm prepare a “hit by the bus plan” for you and key contributors.
Purchase agreements will address pandemics
Purchase agreements used to be concerned with inventory, assets, location, customers, customer concentration, EBITDA, sales, key personnel, etc. Moving forward, these agreements will include the impact of pandemics on your business. Buyers will have language in the purchase agreement that may allow them to walk away from a deal if there is an event similar to COVID-19. Investment bankers and deal lawyers will likely negotiate to reach a compromise between the buyer and the seller.
What you can do: Work with your lawyers and business advisers to put together a process to prepare for such events and the language you would feel comfortable with in a purchase agreement. You should also discuss with management and key personnel the competitive advantages and the impact COVID-19 will have on your business versus your competition.
A new normal for how businesses are sold
Just as we thought we would never have a Zoom happy hour with friends, the process of buying and selling a business is going to be different. In past years, there were one-on-one meetings, site visits, formal management presentations, inventory reviews, contract negotiations, lunches and dinners. That will change now.
Given the fact that most business owners who are selling their business are an older demographic, they will be more immunosuppressant. Social distancing and video conferencing will be more prevalent in the future. Travel and due diligence tours will certainly be muted, but deals may be done with less strain because putting together a meeting will become easier with video conferencing. It won’t replace face-to-face meetings, but it will speed up some of the initial fact-finding elements to the process.
What you can do: Be prepared to have a video conferencing incorporated into your business to hold a virtual meeting. Invest in a good camera and lighting elements to make you and your team look as impressive as you are. The benefit will allow you and your team to be more scripted in the meetings.
Estate planning opportunities have arisen given lower valuations
As a business owner, you recognize there is always an opportunity in the market. The opportunity now with lower equity valuations, a low interest rate environment and the estate tax exemption doubled from the previous 10 years means this is a significant estate planning opportunity. This is especially important if you’re planning to sell your business in the next five years, as you can transfer shares out of your estate into the trust of a beneficiary of your choice.
Additionally, as the CARES Act has provided at least $3 trillion of aid to help stimulate the economy, it is our belief we are going to have to pay that back through an increase in taxes or a reduction in estate tax exemption — or both.
What you can do: Review your current estate plan with advisors and determine the pros and cons of the tax planning opportunities you have in this environment, particularly moving shares within your business to a trust and preparing for increase in taxes moving forward.
America has some of the best entrepreneurial minds in the world, and although COVID-19 has presented its share of problems, you have the option to prepare your business for the future. Now that you understand the environment and the dust has settled, engage with your advisers for the transition of your business when the time is right.