The Impact of COVID 19 on Manufacturing M&A
The ongoing COVID crisis has spurred worldwide uncertainty, with M&A becoming more challenging than ever. The manufacturing sector has seen changes in every aspect of transactions. Here’s what you can expect if you’re planning a transaction.
Beginning the Process
Travel restrictions present many challenges. Many buyers are unable to travel at all. Sellers focused on the safety of their workforce may also be unable to travel. Instead, sellers may film facility walk-throughs while relying heavily on videoconferencing.
Travel restrictions can also make due diligence more difficult. Sellers must be flexible and accommodating, and the parties may need to adjust their timeline to accommodate pandemic-related challenges.
Due Diligence Shifts
Due diligence can be extremely difficult with travel restrictions. One particularly important area is inventory buildup. Some buyers report this is happening as sellers seek to keep their operations running while purchases decline. Buyers should be mindful about this problem, and especially cautious that they do not purchase inventory that might soon be obsolete. Concentrated supplier issues can also be a concern. Sellers should identify any areas of specific impact, then address them well before due diligence.
The financial diligence team also faces new challenges. Buy-side teams must ensure that recent stimulus legislation does not distort financial statements. For instance, whether a seller has utilized a CARES Act PPP loan may significantly affect post-closing operations. Deals which close prior to loan forgiveness may require a holdback or specific indemnity to ensure that the seller, not the buyer, bears the risk of the loan. There’s a similar issue with CARES Act payroll tax deferrals.
Buyers’ legal advisors must also review the seller’s response to the pandemic. Was it flexible? Did they develop new strategies for continuing to operate? Did they prioritize the safety and well-being of their staff, or did they doggedly persist with the old way of doing things in an inflexible manner?
Valuation and Financing Issues
The biggest challenge with most transactions is going to be the way the pandemic affects valuation. Buyers will be reluctant to give full credit for pre-pandemic performance, but sellers will be equally reluctant to reduce the purchase price for something they anticipate will be a short-term crisis. In many transactions, a good idea is to defer some part of the purchase price, and to condition the post-closing payment on specific financial results. Buyers usually hope to base this earn-out on a net profit or EBITDA metric, while sellers prefer gross revenues or a similar bright line metric. Take great care when negotiating these provisions, as well as any covenants regarding post-closing operations.
Similarly, most lenders will no longer be willing to finance pre-pandemic equity: capital ratios. This has increased demand for seller financing. This presents a number of challenges, but it also means that sellers who can finance a portion of the deal may be positioned to ask for more favorable deal terms. In some cases, seller financing may even mean the difference between whether or not a deal successfully closes.
About NuVescor Mergers & Acquisitions
At NuVescor, we align the interests of investors and business owners to enable the personal and financial goals of our clients. For over a decade, we have helped founders and owners of companies in the manufacturing sectors achieve maximum value for their companies. Together, we can provide business valuations, financial analysis, investment guidance, and business transaction advice for middle-market companies with revenues from $5 million to $500 million.