As a seasoned investment banker having lived through the dot.com crash, the Great Recession and now the time of Corona, I have extensive experience with both distressed and growth tech M&A. Distressed M&A is more challenging than growth M&A, but the outcome can be successful with experienced guidance.
It will be fascinating to see how the record amounts of dry powder held by venture firms and private equity firms combined with a global pandemic and global recession will play out. Dry powder, or cash that firms have raised but not invested, rose for venture capital firms for a seventh consecutive year to roughly $276 billion in 2019, nearly triple what it was in 2012. Private equity firms are holding approximately $1.45 trillion in dry powder. US corporations have access to about $2.2 trillion in cash.
My educated guess based on past downturns is that venture firms will focus on keeping their most successful portfolio companies alive and not fund their other portfolio companies. A portfolio company that is not a “winner” should consider entering the M&A market sooner rather than later. Private equity firms will not invest as actively in new investment opportunities, but still will acquire “add ons” to their portfolio companies. Strategic acquirers will not execute as many transformative large billion dollar M&A deals, but will still acquire smaller tech companies as tuck-in acquisitions.
The M&A process for distressed M&A is similar to growth M&A, but speed is paramount.
The Target list should include potential purchasers that have approached the Company in the past, Targets in adjacent sectors, domestic and international purchasers, and private equity firms.
If a Company receives several officers, the winning Target should be selected based on the valuation, the strategic fit, and, importantly in distressed M&A, their ability to execute a transaction quickly. The seller needs to do its own due diligence on the potential purchaser’s track record of closing deals, including average time required to close deals and closure rate. Beware of purchasers that delay the M&A process after they are selected and let the seller run out of cash to strike a better deal.
Once Targets begin make verbal or written offers, consider approaching the current shareholders of the Company for a bridge loan to make it through the M&A process with sufficient liquidity. Potential purchasers will require a balance sheet as part of their thorough due diligence process and will use a Company’s lack of cash to their advantage in the negotiating process.
If an offer contains a decrease in valuation from the last round’s post-money valuation, make sure a Company’s shareholders are in agreement on dividing the consideration offered, especially if the capitalization table is complicated, e.g. with many different rounds and levels of preferences. In a down round, internal approval by a Company’s shareholders can take almost as long as a purchaser’s approval, especially if a Company’s shareholders are taking a very significant haircut.
Be realistic regarding a Company’s valuation and expect lower valuations. Precedent transactions that closed Before Corona (BC) are not as relevant now since valuations After Corona (AC) are lower in general. Comparable companies are a more realistic metric in the time of Corona since the public market valuations reflect the global pandemic.
In distressed M&A, transaction issues are more complicated and take longer to negotiate:
- Third party consents by landlords, customers and intellectual property licensors will take longer.
- Working capital adjustments will be more stringent or assets may be priced on an “as-is, where-is” basis.
- Asset deals will increase versus share deals as purchasers limit their exposure to liabilities.
- Expect more share consideration and less cash consideration as purchasers conserve their own cash.
- Material adverse events clauses will be required and heavily negotiated.
- New due diligence issues are relevant such as in which countries are key suppliers located, e.g. China, and the productivity of remote work employees.
Positive Track Record
As a founder, it is helpful to occasionally step away from the M&A process’ day-to-day machinations and remember that selling the Company is much better than the alternative of shutting the Company down. Maintaining a positive personal track record of successful exits is very important. Three years from now, when a potential investor in your new venture or recruiter for a top level executive position asks what happened to the Company you founded, telling them you sold the Company instead of shutting the Company down dramatically increases your chances of success for the next career move.