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At the start of the Covid pandemic in 2020, there was huge uncertainty around how M&A activity would fare and whether deal flow would continue or grind to a halt.
We experienced a period where deals were put on hold; some never to be picked up again; as businesses prioritised reserving cash while they waited for some of the fog to clear.
For some, I am sure this was caused by a fear of tough times ahead, whereas for others it was a strategic decision to keep cash for opportunities that would inevitably arise as a result of the impact of the pandemic on the economy and certain industries in particular. After this short lull, however, deal flow picked up and since the summer of 2020 we have experienced strong levels of M&A activity, from which we have learned a lot about the types of issues to consider and get right early for a successful Covid era and post-Covid acquisition.
Almost every business has been affected in some way by the Covid pandemic. Some, such as supermarkets, e-commerce, local takeaway coffee shops and others, have largely done well. Others, such as leisure and hospitality, the arts and travel businesses have suffered immensely. What this means is that almost every business has had a period of trading with ‘exceptional’ (be it better or worse) performance. Establishing what is a maintainable level of earnings in a post-Covid world is therefore highly subjective and something that needs careful consideration.
The success stories
For businesses who have experienced accelerated growth, a large hike in sales, or some other benefit during the pandemic, it is important to focus on whether that performance is likely to be maintained post-Covid and, if so, to what extent. Careful analysis of trends driving the increased performance, together with consideration of published information around the expectations of Government bodies or other authorities on how those trends might revert, continue to change, or settle somewhere in the middle, post-Covid, is key to building an informed opinion on future profitability. If a target business’s forecasts have not considered such factors, it is advisable that they are disregarded; or at least discounted to some extent; and the buyer forms their own opinion.
The less fortunate
For businesses who have suffered during the pandemic, there are certain key matters to consider, which include but are not limited to, the following.
Will the business’s performance return to pre-Covid trading levels, or better?
- If management think that this can be achieved, have they considered the possible changes in trends and the wider economy, mentioned above?
- If yes, in what timeframe?
- Is the time-cost of money material?
- If the business is making losses, does it have enough cash to survive until it reaches or returns to profitability, or will the buyer need to inject cash?
If no, have management changed their strategy?
- If they have, how reliable are management’s forecasts?
- Does the new strategy make historical trading results irrelevant for the buyer?
The questions above are asked in order to aid the assessment of a maintainable level of earnings. It is clear that any number given to post-Covid maintainable earnings will be subjective, particularly for those businesses in industries that have suffered the most, but having regard for the above (and other transaction-specific considerations), a buyer should have a good amount of information on which to base their opinion.
Working capital is an important element in most corporate transactions and agreeing a ‘target’ or ‘normal’ level of working capital, for the purposes taking account of any surplus or deficit at completion, is a subjective task.
As with trading performance, the working capital of businesses has generally been significantly affected during the pandemic. For business whose trading has suffered, the reasons for this are obvious, but businesses whose own trading may have fared well might also have experienced working capital constraints, as a result of slower payments from key customers who are managing their own cash constraints, amongst other things.
What to look out for during the pandemic and post-Covid:
Historical bad debt provisioning policies are likely no longer fit-for-purpose and careful consideration should be given to the level of debts that are doubtful or irrecoverable. These should be adjusted for and this is usually done by way of a specific accounting policy in the completion accounts.
As businesses have stretched out their working capital cycle to retain cash, or offset longer debtor days, as larger proportion of accounts payable may have become old and overdue.
Ensuring overdue payables caused by the pandemic are excluded when calculating the normal working capital will usually provide protection for the buyer. It may be preferable to exclude such items from working capital entirely, treating them as ‘debt-like’ items and having a specific deduction for them in the completion accounts.
VAT deferral scheme liabilities
Many businesses have taken advantage of the Government’s VAT deferral scheme and consequently have large, exceptional VAT liabilities on their balance sheets. Whilst VAT is often included within working capital, consideration should be given to the exclusion of the deferred VAT amounts from working capital. Treating such amounts in a similar way to debt and making deductions for them in the completion accounts should provide protection for the buyer.
Government loans and grants
The Government has provided support to businesses in various ways over the last year, including in the provision of subsidised loan schemes and the coronavirus job retention scheme.
Ensuring the appropriate treatment of such items in the completion accounts is an important matter to consider before a transaction, as well as ensuring that the business was eligible for the Government support and fulfilled all of its duties and obligations in connection with the same.
It is expected that there will be a major operation run by HMRC and other government bodies to investigate mis-use of the coronavirus support schemes. A risk therefore exists for buyers, who may end up paying back such support amounts, or even worse. A careful review of all Government support received under the various coronavirus support schemes as well as the business’s eligibility for and compliance with its obligations under the same is an important element of financial due diligence to be undertaken for Covid-era and post-Covid deals.Back to top