Like most aspects of the business world, the global economic crisis has affected merger and acquisition activity in unprecedented
fashion. Mergers and acquisitions historically have been a key driver of corporate growth, but the activity has all but ground
to a halt.
While many factors have conspired against these once-plentiful transactions, three phenomena are principally
responsible for the recent decline—lack of available credit, disparate expectations between sellers and buyers, and
hesitance on the part of buyers to deploy their capital.
Most acquisitions are fueled by debt. Buyers borrow most
of the purchase price and fund the balance with equity. This allows the buyer to risk less of its own capital and “leverage”
its return on investment.
For years, lending markets have provided a deep pool of debt on favorable terms. The
result was an unprecedented volume of acquisitions.
The collapse of global credit markets greatly constricted availability
of traditional debt and in many cases made it unavailable. This has been the greatest obstacle in getting deals done in 2009.
Another seemingly obvious element of a successful transaction is agreement between the buyer and the seller on price.
When the economy was going well and there was a fluid market for companies, buyers and sellers readily agreed on company valuations.
When the recession hit and the market dried up, valuations became less clear. Buyers started proposing lower purchase
prices as sellers’ operating results suffered.
These buyers have found that owners of good companies are
not willing to sell at a discount. They simply have taken their companies off the market and plan to wait out the recession.
The remaining companies must sell, thus are often unattractive and even more difficult to finance. This disparity
between purchase price expectations of buyers and sellers has further quelled M&A activity.
Further, for any
transaction to close, the buyer must deploy some of its own capital. Because of rampant economic uncertainty, buyers are wary
of spending their money now out of fear we may not have yet seen the bottom.
Buyers also fear deploying available
capital because they are not certain when they might be able to raise more. This reluctance to invest has kept many buyers
out of the market.
The confluence of these factors means deals closing today look very different from deals that
closed even a year ago. Without available credit, buyers are now looking to sellers to finance some, or all, of the purchase
This has led to the advent of “seller secured senior financing” in which the seller provides
senior debt to fund the acquisition. This debt is structured to be taken out by new senior debt once the credit markets return
Also, many deals now provide for some contingent portion of the purchase price, often known as an
earn-out, which is paid if the company achieves certain financial milestones.
Buyers, too, have been forced to
make concessions. The portion of the purchase price funded with equity has steadily increased as advance rates on senior debt
Buyers also have been steadily acquiring companies out of bankruptcy or in foreclosure sales in
which they trade a lower purchase price for far fewer representations and warranties and little to no recourse if things go
badly after the closing.
What this all means for the balance of 2009 and beyond is the subject of great speculation.
Nevertheless, some things seem clear.
First, it will be a while before credit markets return to something approximating
normalcy. Until lenders make credit available for acquisitions on commercially reasonable terms, financial buyers (such as
private equity and venture capital funds) are largely sidelined. Well-capitalized strategic buyers who can fund acquisitions
from existing capital and credit lines are likely to get the lion’s share of the deals.
Second, for financial
buyers to compete for companies, they must get comfortable deploying capital, and more of it, to get deals done. They also
will have to partner with sellers and other capital sources to find alternatives to traditional senior lending model.
Finally, buyers and sellers need time to find a common ground on valuations. Buyers must reset expectations of “stealing”
good companies and sellers must appreciate that their companies are not worth what they once were. Until these expectations
meet, deals will be few and far between.
While the M&A climate seems dire for 2009, there is a silver lining.
Well-capitalized buyers with the courage to deploy their capital, and the creativity to finance transactions and accommodate
sellers’ purchase price expectations, have a historic opportunity to acquire companies at unprecedented valuations while
many of their traditional competitors remain on the sidelines.•
Caruso is a partner
in the business and finance department at Taft Stettinius & Hollister LLP. Views expressed here are the writer’s.