At the start of 2020, the mergers and acquisitions (M&A) outlook was very positive for U.S. accounts receivable management (ARM) companies. The economy was strong. Public stocks were performing consistently well. Unemployment levels were at record lows. Consumer confidence was high. Companies and governments were outsourcing noncore business functions to third party specialists at increased rates. Regulations were finally being clarified. Most ARM companies were performing very well (Kaulkin Ginsberg research shows that ARM companies returned $90.1 billion to the economy). The M&A markets were attractive for buyers and sellers alike.
Then in March 2020, the global coronavirus pandemic set in and everything abruptly changed. Most owners who were thinking about selling their company changed their focus to safely moving their employees’ home to work. Some credit grantors and government clients ceased collection activities into specific regions, and for certain types of accounts, such as student loans. Over the next 6 months, coronavirus-related cases increased significantly across the country, preventing some buyers and lenders from getting comfortable that the terms of their transactions would account for potential downturns. Starting in September, business buyers and sellers alike turned their focus on the November elections. M&A activity slowed immensely as sellers and buyers were forced to reassess budgets and forecasts to account for the impact of the virus. Representations and Warrantees provisions were closely scrutinized so buyers were not left “holding the bag” if sellers underperformed during the pandemic. Due diligence processes also slowed to a crawl as travel came to a virtual halt. A new crop of vulture-type business buyers emerged, sending letters directly to owners and connecting with brokers to express their interest in acquiring underperforming companies at bargain-basement prices. Most buyers and sellers decided to slow down their own processes and took a more “wait-and-see” position when it came to M&A.
How has pricing been impacted during the global pandemic?
How transactions are being priced and structured is always a major concern among buyers and sellers in any market. Historically in the U.S. ARM industry, experienced acquirers typically determined the value of the selling ARM business by assigning a multiple to the selling company’s normalized, or adjusted, earnings before interest, taxes, depreciation, and amortization (known as EBITDA). In most cases, closely held firms’ financial matters have been transacted to minimize tax liabilities rather than to provide an economic picture of the company’s true profitability. Most experienced buyers believe the most reliable indicator of a future income stream is determined by normalizing, or adjusting, the selling company’s historical and current EBITDA to account for any excessive or one-time operating expenses.
Starting in Q3 2020, we added the letter C to the end of EBITDA to account for any temporary revenue reductions and one-time (non-recurring) expenses associated with the coronavirus pandemic. These EBITDAC amounts now include, but are not limited to, the following:
- Any temporary loss of revenues attributed to client and/or governmental mandates to temporarily cease collection activities either into certain regions or toward a type of client account;
- All direct, non-recurring expenses associated with implementing work-from-home mandates; and
- Treatment of any stimulus PPP small business loans obtained by the selling company.
In today’s volatile market, some sellers are realistic with their expectations while some are desperately trying to hold onto 2019 valuations, citing concerns that performance downtowns are only temporary, and their revenues and profits will rebound, so they should not be penalized with a lower purchase price if they were to sell their company during the pandemic. Most experienced buyers will continue to look closely at historical financial performance, but they tend to assess the value of a selling business based upon current year, and trailing-twelve-month, performance indicators. This creates the potential for a huge gap in pricing between buyer and seller in today’s market. Some buyers are looking to bridge that gap with longer earnout periods so they can share the risk of performance fluctuations with the seller, whereas most sellers still want cash-heavy transactions if they were to part with their company.
Kaulkin Ginsberg produced a comprehensive presentation about pricing in today’s market, which is available upon request.
Buying and selling companies is a challenge in any market. During this pandemic, it is even more challenging to complete M&A transactions. Our experts welcome the opportunity to confidentially speak with you about your needs. If you have any questions, please contact us at firstname.lastname@example.org.