1. Focus on your core M&A strategy
The successful legacy of deals struck during the pandemic and in the aftermath of the 2008 financial crisis proves strong deal fundamentals and thorough due diligence can consistently achieve results from M&A. By maintaining focus on a core M&A strategy, even in an uncertain macroeconomic environment, you can exploit the right market opportunities. You can achieve this while also minimising risk, delivering a business plan and ensuring shareholder value is maximised.
When developing your strategy, consider things like the definition of strategic and financial goals, what you would like your business to look like in five years time and what type of synergies are expected from the acquisition.
2. Don’t be distracted by bargains
It's expected that there will be a rise in distressed assets. This is particularly true for consumer-facing sectors. However, a tempting sale price combined with the pressurised timescales of rescue deals can lead to an increased risk of an unsuccessful outcome. That's not to mention the management hours required to reverse underperformance and the opportunity cost of the distraction – time that would be better spent elsewhere. Therefore, it's essential to focus on your core M&A strategy.
3. Be realistic about deal valuation
Rocketing interest rates have increased the cost of debt. This directly impacts leveraged buyouts, as valuations must come down for investors to achieve target returns. In the meantime, sellers are wary of accepting lower valuations on the basis of short-term economic trends. As is standard in M&A, it will take time for expectations to normalise on both sides. This may not happen until the second half of 2023 when there could be greater visibility regarding current macroeconomic headwinds.
4. Earnouts are essential
When negotiating this element of the deal, it's vital to invest time in structuring the earnout to ensure you are incentivising favourable behaviours and the best possible outcome from your purchase.
Earnout agreements should be a core part of a preferred deal structure for three key reasons:
- They mitigate valuation disputes and help bridge any price expectations gap;
- During a skills shortage, they can ensure key employees remain within the acquired business; and
- They reduce the forecast risk incurred by an acquirer, particularly in a turbulent economic market
5. Don't make assumptions about consumer behaviour
Whether the target business is business to business (B2B) or business to consumer (B2C), avoid assumptions on how the end-customer will behave during an economic downturn. For example, the cost-of-living crisis has forced some environmentally committed consumers to trade down from sustainable products. But this has been offset by the emergence of ‘light green’ and ‘medium green’ consumers, who are increasing household spend on certain sustainable products.
In New Zealand, over 50% of consumers now earn and save less, but spend more, according to the latest NZ consumer sentiment series. They are expecting to spend more on essentials such as utilities, food and groceries, mortgage and insurance and less on discretionary items to deal with the impact of inflation. Climate change and sustainability have also recently become top considerations when making a purchase. More than ever, due diligence must include thorough research into end-customer dynamics.
6. Leverage your specialism
If you have in-depth sector knowledge and strong operational capability within your team, and an opportunity arises within a sector or industry you know well, you can respond quickly to the opportunity while generalist investors, such as Private Equity or Family Offices are still weighing up risk.
7. Factor the labour market into your M&A due diligence
Headline layoffs at the world’s biggest tech companies suggest the labour pool is growing, at least for mid-skilled workers in the US. New Zealand, however, is still facing labour shortages, with sectors such as hospitality, retail, healthcare, manufacturing and construction being most affected. Therefore, for companies to remain competitive, they must continue to invest in technology and skills training.
When evaluating the growth potential of a target that relies on a section of the workforce with a constrained labour market, this should be factored into the achievability of the business plan.
8. Consider the FX impact
Due to New Zealand's small size and long distances from world markets, foreign trade is an integral part of the economy and creates significant challenges due to exchange rate fluctuations and exposure to supply chain disruptions. Therefore, given the current macroeconomic instability, due diligence into the strength and robustness of the supply chain, as well as consideration of the exposure to movements in foreign exchange are likely to continue to be an important part of the due diligence process.
When M&A is the next logical step in your business’s growth journey it can be as exciting as it is risky – particularly in a downturn. The key is starting with a strong strategy and focussing on the key fundamentals of the deal along the way; this will set you up for success well beyond your purchase.