The coronavirus (“COVID-19”) pandemic has significantly affected merger and acquisition (“M&A”) activity worldwide. Even in the first quarter of 2020 compared with 2019, M&A activity was down 25%. The market downturn and related financial crisis caused by COVID-19 have further decreased M&A activity. Many companies delayed or scrapped deals entirely due to concerns over financial uncertainty. While others have moved forward cautiously with their deals, perhaps with renegotiated terms.
Despite the initial impact of COVID-19 on M&A, buyers looking for strategic M&A deals have myriad opportunities in the wake of COVID-19, and as states begin to reopen there should be an uptick in M&A activity. Despite the negative effects COVID-19 has had on various industries, certain businesses are thriving and will continue to be attractive acquisition targets. In addition, buyers with cash or readily available financing will have numerous opportunities to acquire distressed businesses. This article highlights potential M&A opportunities and provides insight on how sellers can start preparing for the transaction process.
Technology-Based Services and Companies
M&A activity in technology-based services, such as telemedicine, has begun to pick up. Prior to COVID-19, the healthcare industry was slow to adopt the use of telemedicine as an alternative to in-person patient care. However, COVID-19 has accelerated the widespread use of telemedicine by healthcare providers and patients. Since February 2020, telemedicine investments have increased to over 30% of investment activity in health IT. This shift has created a large potential for increased growth and dealmaking in the telemedicine sector.
Similarly, the technology sector has experienced and will continue to experience strong M&A activity. Technology has been one of the areas least impacted by COVID-19 and should be the quickest to recover. For example, Microsoft has already acquired two software companies in 2020 — Affirmed Networks Inc., a 5G software developer, and Metaswitch Networks, a telecommunications software developer. Telecommunications companies similarly have
experienced a boost due to the various work-from-home orders and policies, as well as an increase in demand for strong home connectivity. Buyers are likely to be looking for growth opportunities and new investments in technology and telecommunications in the aftermath of COVID-19.
Unfortunately, the pandemic has decimated a number of businesses. This cycle will result in a number of such businesses being available for acquisition, and there will be increased transaction activity stemming from acquisitions of distressed businesses. Buyers and investors will have opportunities to purchase distressed businesses through a regular sale process or through the bankruptcy process. Industries that have been significantly affected by COVID-19, such as travel, leisure, transportation, restaurant, and oil and gas, will see an increase in M&A activity as buyers see strategic opportunities for bargains in these industries.
Buyers can similarly expect to see bargains on assets of distressed businesses. A distressed asset sale may present strategic opportunities for buyers that may not have been available pre-COVID-19, such as entering into an untapped market, entering into a new business space, reducing completion or optimizing current operations.
Unique opportunities may also arise from business owners who were on the fence about selling their business pre-COVID-19, but are now willing and ready to sell after experiencing the uncertainty of the pandemic. Demographically, the number of business owners at or nearing retirement age is at a peak. In previous downturns, business owners have often opted to focus on their business and wait for the M&A market to recover. However, this pandemic has had such widespread impact on businesses and their owners that many will simply decide selling now is more important that waiting for valuations to return to pre-COVID-19 levels.
There will likely be more opportunities for strategic buyers to compete in M&A activity due to a drop in private equity activity. Private equity firms are focused on stabilizing their current portfolio companies affected by COVID-19. In addition, with the current uncertainty in the finance market, private equity deals traditionally funded through debt are moving at a much slower pace. Lenders are focused on existing loans and have yet to fully assess what the availability and terms of such debt financing will be. While cash transactions have been the norm during the past 10 years, there will be an increase in the use of stock or other equity to finance transactions, which will benefit public strategic acquirers.
Preparing to Sell
Companies thinking of selling should begin preparing for a potential transaction now. Because of the dramatic short-term effects COVID-19 has had on businesses, sellers can expect increased due diligence efforts focused on the impact of the pandemic on their business. Buyers will want to understand the overall economic impact of COVID-19 and any associated risks.
Sellers can expect significantly increased and more thorough due diligence efforts on the company’s finances, including financing arrangements, liquidity, and risk of insolvency. Diligence requests may include the status of all revolving credit lines, communications with lenders, loan modification agreements, and financial obligations. Buyers will want to know whether the target received any funding under the Coronavirus Aid, Relief, and Economic Security Act and whether the target is in compliance with the applicable federal requirements, including any loan forgiveness opportunities.
Sellers also can expect diligence requests to focus on how the pandemic effected the seller’s operations and how the seller responded to those disruptions or changes. Diligence may cover areas such as internal COVID-19 policies regarding working conditions, COVID-19 related communications with customers or suppliers, the company’s IT infrastructure, customer contracts and supply chains. Sellers should prepare for requests regarding compliance with COVID-19 employment regulations, compliance with applicable laws related to furloughs, layoffs or other cost-saving measures, and compliance with any applicable shelter-in-place orders.
It will be critical for sellers to be able to demonstrate how COVID-19 has impacted the company and provide a supportable assessment of what the “new normal” will look like for the company. Having comprehensive COVID-19 responses and policies will help sellers assuage buyer fears about post-closing liability for COVID-19 matters.
While COVID-19 has caused market downturns, it has provided numerous strategic and unique opportunities for buyers and sellers. As M&A activity begins to increase, companies should evaluate these market trends and their long-term goals to determine whether to pursue M&A transactions.
Written by Mark D. Williamson. Here’s what you’ve missed?
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