Articles > M&A for SMEs to Get Beyond Covid-19? Here’s What you Must Know First

M&A for SMEs to Get Beyond Covid-19? Here’s What you Must Know First

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FinLab Admin
By Ian Lee, Content.co

Are mergers and acquisitions (M&As) a good idea for companies looking to survive beyond Covid-19? In this article, we will deep dive into this question, beginning with what private M&As are.

 

A quick intro to private M&As

M&A is simply the process of a company merging with or acquiring another company. This can involve a partial or total buyout of either the business’ equity or assets—payable in stock, cash, or a combination of both. Or it can be two entities merging into an entirely new one.

 

M&As in the time of COVID-19 – is now the right time?

As you might expect, during tough economic times—such as now—M&A deal flow stagnates. For instance, data provider Refinitiv reported that, as of April 2020, worldwide merger activity had fallen by 33%, with the number of deals falling 20%—the lowest year-to-date amount since 2013. But this doesn’t disqualify M&As as a viable business continuity strategy.

 

A March 2020 EY report, which surveyed almost 3,000 global executives, found that many companies looked at these times as an opportunity to purchase high-quality assets at more attractive valuations. A follow-up piece by EY, focusing on Asia Pacific executives, noted that 57% expect the M&A market to improve locally. 52% also intend to pursue M&A transactions in the next 12 months.

 

This is higher than the 10-year average and equal to the figure six months ago, before the crisis.Thus, we can broadly separate SMEs into two distinct buckets: those whose businesses are struggling amid the pandemic (the supply), and those who are doing well and may in fact be looking to expand (the demand).

 

The existence of both supply and demand—even in these times—means that M&As are still viable as both a business continuity strategy and opportunity. Let’s look at each of these in turn.

 

M&As for business continuity (and an important consideration)

If you are a business that is struggling to stay afloat, the good news is there is demand that could lead to a potential acquisition of your company. The reason many SMEs are floundering right now have to do with near-term cashflow issues, where business deals are drying up but the cost structure remains mostly unchanged.

 

A M&A would give your business a much-needed capital injection which it could use to ride out the short-term turbulence. Beyond this, there can and should also be longer term benefits. Consider the three main types of M&As and their associated advantages. Note that, in the finance world, mergers and acquisitions are often used interchangeably

 

  • Horizontal mergers: Between companies that offer the same type of products and services to the same market to increase market share
  • Vertical mergers: Between companies at different stages of the same supply chain, to achieve synergies
  • Concentric mergers: Between companies within the same industry that target the same customers but with different products and services, to expand product offerings

 

However, when contemplating M&As for business survival during times of economic distress, there is one important consideration—valuation. If you need to sell your business for it to survive, what implication does that have on the price you would be able to get?

 

Valuation is the most important trade-off SMEs in this category must consider and be prepared for. For instance, if your profits or revenue is declining, this will impact your earnings multiple, which is one of the common valuation methods, and dilute the valuation of your business.

 

M&As as a business opportunity

Ironically, it is the lower valuations during such a time that drives up the interest in M&As as a good time to pick up companies at good value. An analysis by Bain of 24,000 M&A transactions found that acquisitions completed during and just after recessions generated almost triple the returns compared to those done in the boom years.

 

As Bain notes, the biggest strategic opportunity for acquirers during downturns is two-fold—strengthening the core business and creating strategic options for the post-recession landscape. Indeed, the post-COVID-19 business environment will be a changed one and businesses that have the capability can actively look for strategic acquisition opportunities to grow market share, product offerings or synergies. These can all help the acquiring company achieve its long-term strategy.

 

M&As bottom line – both opportunity and trade-offs exist

Despite economic conditions, demand for M&As exist. For SMEs looking to M&As for business continuity, they must weigh the opportunity for an acquisition against the likelihood of lower valuations. And for SMEs that are thriving and looking to expand, seeking out strategic M&As could have the potential to deliver above-average returns, given the lower valuations in play.

 

One potential solution to lessen this trade-off is through a partial buyout. In this scenario, you retain an ownership stake and may have the option to sell the remaining stake down the line once valuations improve. In the private equity world, this is also referred to as a recapitalisation. However, this option comes with considerations around operating control since the owners’ share would be diluted.

 

A checklist for SMEs considering M&As

If you think M&As are a potentially viable option for your business, use the items below as a checklist to make sure you properly evaluate the standard considerations.

 

  • Goals and expectations
Understand clearly the why of the deal and what you expect to get out of it. Is it business survival, gaining market share, achieving synergies, getting access to new channels or other objectives?

 

  • Valuation
Valuation is both art and science, involving financial analysis and effective negotiations between both parties. While there are standard quantitative metrics like earnings multiples, opportunity costs, and financial projections, qualitative considerations such as synergies, strategic fit in operations and human capital, ownership of intellectual property are also influencing factors.

 

  • Structure
Various structures fall under the M&A umbrella. As a broad example, in the case of an acquisition, you can either acquire all the stock in a company or purchase all its assets. Typically, mergers are all-stock affairs, while acquisitions often involve cash considerations. The regulatory environment, which will vary by jurisdiction, and financing (if necessary) must also be accounted for.

 

On top of all these, not every M&A necessarily involves a full acquisition—there are also partial buyouts to consider. It all depends on the amount of your company you are selling. If it is a smaller piece, then a partial buyout is essentially the same as taking on a new outside investor. But if it is a larger or even majority stake, then the same full acquisition considerations must be accounted for.

 

  • Due diligence process
M&A deals require extensive due diligence. How can you plan for this in advance to make sure all financial accounts are properly audited and all relevant business information organised and accessible to the other party?

 

  • Post-deal integration
The inking of the deal doesn’t mean that the work is over. Planning should be done ahead of time on how the integration in terms of systems, processes, and people will be handled. Note that in the case of a partial buyout, post-deal integration would be less of or not even a factor at all.

 

M&A alternatives – external investments and strategic partnerships

Of course, M&As aren’t the only option available to SMEs. Two common alternatives are seeking external investments and forming strategic partnerships.

 

The first alternative—seeking external investments—has similar opportunities and trade-offs as M&As. In fact, getting an external investor can be akin to a partial buyout. However, the process is typically faster than a M&A. Since equity financing is based on valuations, SMEs must once again weigh the need for fresh capital against the cost of diluting equity ownership.

 

The second alternative—strategic alliances—are a looser form of M&As. Here, the contractual relationship between the two parties can range from “handshake” agreements to joint ventures and equity alliances (purchasing each other’s stock). Because of this contractual flexibility, they can be executed much faster than M&As and businesses can avoid dealing with the thorny issues surrounding valuation.

 

The current situation is unprecedented. There are no quick and easy “one size fits all” solutions to the troubles many SMEs are facing right now. Opportunities exist, but so do trade-offs. Key questions businesses can think about to guide decision making are:

  • The short- and long-term objectives of the business and how the M&A transaction meets these objectives.
  • How do the financial projections, opportunity costs of capital and resources, plus qualitative considerations such as fit, control and integration stack up against other alternatives?”.

 

Besides M&A, businesses typically fund their working capital from bank borrowings. If you are looking to get banking and financing support, click here or drop us an email, and we’ll connect you with UOB to share more. 

 

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