What’s next? The M&A market, too, faces an uncertain future
The virus pandemic has struck the German economy at a time when it was already weakened by last year’s downturn. The federal government has reacted quickly and put together packages of measures for businesses and the self-employed. It is not yet possible to estimate how quickly these measures will take effect.
Current Situation
This uncertainty is currently shaping the market for corporate acquisitions and divestitures as well. At the start of the pandemic, entrepreneurs’ priorities shifted toward short-term crisis management.
General Market Trends
In times of crisis, activity in the M&A market typically declines. This was already evident during the collapse of the “Neuer Markt” in 2002–2003 and also during the economic crisis of 2009. Company valuations are falling, and the cost of capital for acquisition financing is rising.
In the current virus crisis as well, many companies will face rising debt or even liquidity shortages.
The number of companies considering raising capital through (partial) sales—as well as distress sales (asset deals)—will increase as a result of the crisis. Consequently, the purchase prices offered for these companies will also come under pressure.
The seller’s market that has prevailed in recent years is expected to shift to a buyer’s market.
It can be assumed that this will be more noticeable in some industries (e.g., mechanical engineering, automotive suppliers) than in others (e.g., medical technology, IT), which continue to generate stable demand and earnings even during the pandemic.
The good news: Despite the pandemic, institutional investors and strategists who invest countercyclically remain interested in acquiring companies. The prevailing investment pressure could even be intensified by a potential bursting of the real estate bubble as a result of the pandemic.
Changes in the Transaction Process
The transaction process is also changing as a result of the pandemic.
In-person meetings between buyers and sellers will be limited—particularly in the event of prolonged travel restrictions—and will be replaced by virtual meetings. The success of a transaction will depend heavily on whether the parties succeed in establishing a basis of trust for future negotiations even in the “virtual space.”
Based on the experiences of recent months, buyers will place great emphasis during due diligence on the factors that prompted the sale of the target company. This is because, during a crisis, temporary security is often purchased at the expense of future growth. This short-term approach can have correspondingly negative consequences for the buyer in the post-crisis period, which must be avoided.
The determination of the purchase price and the drafting of contracts will increasingly be structured in a buyer-friendly manner. When calculating the purchase price, it is expected that closing accounts (previously known as “locked boxes”) will be used more frequently to ensure that the economic risk during the transaction period remains with the seller as much as possible.
Similarly, earn-out clauses—which tie partial payments of the purchase price to the achievement of specific targets (revenue, EBIT, etc.)—will once again become more common. The purchase agreements will include comprehensive representations, warranties, and MACK clauses *.
Conclusion
Many of the companies that have found themselves in a difficult situation as a result of the pandemic are fundamentally profitable and strategically well-positioned. Their problem often lies in a capital structure that is unsuitable for crises.
Even during the crisis, these companies have a good chance of securing a fair purchase price. Companies that were already experiencing structural difficulties prior to the crisis will now find it difficult to find a suitable buyer.
For well-capitalized companies and institutional investors, this presents an opportunity to invest in future growth through targeted acquisitions, thereby ensuring they are optimally positioned for the post-crisis period.
* “Material Adverse Change” clause: This clause allows buyers to withdraw from the contract or renegotiate its terms if a material adverse change occurs at the target company or in its market environment between the signing and closing of the transaction.
