Buying a business – seven key considerations

The global COVID-19 pandemic has created widespread economic uncertainty. As the world continues to fight against the health crisis that has shaped 2020 to-date, commercial activity in many sectors has all but stopped. The short-term impact will be severe, with many businesses struggling to sustain themselves. However, while the depth and duration of this crisis is uncertain, it will pass.

We have all heard the Chinese word for crisis is made up of two symbols meaning danger and opportunity. There is no doubt that at this time of uncertainty there is great danger for business. But equally, the crisis presents an opportunity to reassess the strategic direction of the business and identify new ways of operating.

If we look back to shocks like the global financial crisis in 2008-10, it presented an opportunity for businesses who had the capital and appetite to make bold strategic moves. Some acquired high-quality assets which gave them the platform to faster growth and greater market share in the upturn.

After a period of strong economic growth, many companies with robust balance sheets and ambitious horizons might see the current decline as an opportunity to strategically position their business for the longer-term, engaging in transformation, consolidation, diversification or strategic alliances.

Most business owners are expecting a U-shaped recovery — a period of slower economic activity extending into 2021, before recovery takes hold. Some are more optimistic, hoping for a V-shaped recovery by early next year. Whatever the case, what is sure is that M&A opportunities on the buy side will emerge as a result of this crisis.

When the recovery does emerge, it is important that you are best-placed to avail of these opportunities. We identify below the key considerations in respect of acquiring a business in a post-COVID-19 setting:

1. Strategic rationale

It is vital to plan ahead and anticipate what’s next for your business and industry. This may have changed as a result of COVID-19 and it is worth revisiting your previous plans. Your vision for the future should inform your M&A strategy, providing you with clear objectives and goals. This may be to enhance your digital transformation, to diversify into new markets or activities or to consolidate your position through the acquisition of high-quality businesses and assets.

It is important to critically assess each acquisition opportunity against your own strategic objectives.

Due to the impact of financial distress you may come across acquisition opportunities at attractive valuations. However, you must apply the same principles to acquiring a business as you would in ordinary circumstances: Does the business enhance your offering? Is the business a sound strategic and operational fit?

As a general rule of thumb, you should critically consider whether you see the business as a viable acquisition target before taking into account any potential price discounts, which may have enhanced its appeal.

2. Valuation

COVID-19 has made valuing an acquisition target much more complicated. The starting point for the majority of business valuations is a forecast of future profits and cash flows. Profits for most businesses have been impaired in the short-term. Therefore, a key question in assessing an acquisition target is to estimate how the business will perform during the crisis and beyond. 

When forecasting profits, it is important to be realistic, rather than optimistic or pessimistic. Developing a realistic forecast will involve a detailed analysis of company-specific factors such as its underlying demand drivers, its market share, its brand recognition and positioning, its operating processes and the quality of its management team. While many forecasts are based on past trends, consider whether this is a valid indicator post COVID-19.

Capitalisation multiples should also be considered depending on the level of volatility and uncertainty within the business and sector.

3. Deferred consideration

Due to the impact of COVID-19, there may be added uncertainty around forecasts and valuations in the short to medium term. One way to address this uncertainty, while achieving a mutually agreeable consideration, is to include an element of deferred consideration, which is dependent on future performance, as part of the overall consideration. From a buyer’s perspective this should protect you against over-paying for the business, while also creating alignment of interest with the vendor.

4. How will the transaction be financed?

While funding the acquisition solely from internal resources makes a transaction easier, it is frequently not feasible. 

If you do need external finance to make a transaction happen, you should consider whether it will be possible to agree that the vendor provides a loan note, effectively deferring an element of the consideration. This is a common feature of many SME transactions.

Alternatively, you may need to arrange a loan with a bank or other lender to part-finance the transaction. Credit decision-making will slow down as a result of COVID-19 and you should pre-empt this by engaging with your lenders at the earliest opportunity. You should anticipate their requirements by preparing a detailed business plan and financial model demonstrating the profits and free cash from the transaction. Where borrowing, it is important to factor the cost of capital into your overall assessment of the deal.

Having finance in place early in the process will reduce the risk of a transaction failing to complete.

5. Undertake detailed due diligence

It is imperative that you fully understand the impact that the COVID-19 crisis will have on the future sustainability of the target business. Key questions to consider specific to COVID-19 are:

• How is the financial performance of the business impacted by COVID-19?
• Are the recovery plans reasonable and achievable?
• Are the key customers and suppliers for the business sufficiently viable? If there is a reliance on key cogs in the supply chain, you need to ensure that these businesses can continue to provide or continue to avail of your goods and services.
• Are there employment law considerations arising from how staff were managed during the crisis? You will be assuming the position of employer for all these staff when you acquire the business. Legacy issues will be transferred to you on acquisition.
• Are there potential claims against the business arising from the crisis?

6. Consider the optimal acquisition strategy

Businesses are generally bought via share or asset acquisition. In a share acquisition, you step into the ownership of the legal entity that operates the business, whereas an asset acquisition results in the specific assets of the business being transferred into your ownership.

There are tax implications to be considered for both approaches, such as stamp duty, VAT, capital gains tax and future corporation tax. With a share acquisition, you inherit historic issues in relation to tax compliance and for this reason a detailed tax due diligence should be conducted. With an asset acquisition, you will need to investigate if historic VAT and payroll taxes have been treated correctly as it may impact the profitability of the business you are acquiring. 

There are numerous financial and non-financial risk factors to be considered under a share or asset structure. On the assumption that the vendor is open to considering both options, it will be important that you perform a detailed risk assessment to determine the most suitable structure for you.

7. Ensure that the legal documentation is robust

In the event of a share acquisition, your solicitor will prepare a share purchase agreement (SPA), to be agreed by both parties. 

As a result of COVID-19, there is increased focus on Material Adverse Change (MAC) clauses. From a buyer’s perspective you will want to ensure that the clause is robust and provides you with protection to allow you terminate or adjust your obligations in the event of a change in circumstances. Such clauses can be interpreted narrowly so it is important that it is carefully considered with your solicitors in the negotiation phase.

You should ensure that you are adequately protected in the agreements in the event of information being misrepresented or not disclosed during the sales process. You should seek to agree specific warranties and indemnities in the SPA that will give you recourse in the event of these warranties being broken. Depending on the circumstances it may also be appropriate to seek that an element of the consideration is held in escrow for a defined period of time to cover any potential warranty or indemnity claims.

In conclusion

While the short-term focus is naturally on managing your business through this difficult period, there will be opportunities for strategic acquisitions that position your business for the longer-term. You should take proactive steps by reviewing your strategic plans and consider how acquisitions can help you achieve your goals.

At Crowe, our dedicated corporate finance team have extensive experience helping our clients grow, buy and sell their business. Our experienced team are here to support you with your expansion plans and fundraising activities. We are ideally placed to help you recognise and maximise opportunities, helping you make smarter decisions today that create lasting value for tomorrow.

If you are considering the sale or purchase of a business we can help you maximise your investment. Talk to our corporate finance team today.