Over the past three years, the Covid-19 pandemic resulted in significant disturbances to the world economy, with the aftershocks resulting in supply chain issues, inflation, and rising interest rates.
Economies ground to a halt at lightspeed yet opened at differing speeds. This resulted in worldwide trade being fractured, with both national governments and businesses having to navigate their way through a myriad of challenges in different territories.
With Covid behind us, we are now facing rising interest rates and stubbornly high inflation
Over the last 18 months, due to the economic uncertainty we have seen a reduction in the number of M&A deals, which is understandable; no one likes uncertainty.
Central Banks worldwide are using the rise in interest rates to help manage and reduce inflation. This has resulted in an increase in cost of borrowing for those exposed to variable rates. Not only has it become much more difficult to obtain financing, but affordable financing is scarce; lending requirements are much more stringent and the appetite for lending is weak.
With future interest rate rises on the horizon, and inflation still being stubbornly high, the light at the end of the tunnel is not yet in sight. Dealsuite – the largest and most active community of dealmakers in Europe reported a, a significant decrease in buy-side transactions in the United Kingdom and Ireland in H2-2022 .
For years, the average multiple for your typical SME ranged somewhere between 3x and 5x normalised profits. In H1 2022 , Dealsuite saw the average multiple for UK and Ireland rise to 5.40, however as interest rates have risen, causing a decline in available finance and buyers, the average multiple showed a notable reduction to 5.1 in H2-2022.
However, it might be easy to fall into the trap of thinking that it is not a good time to undertake M&A deals. On the contrary, we think the opposite; now is the time to consider the strategic direction of your business and leverage the lower valuation multiples to acquire businesses that can add value on provide good growth, with the key focus being on mid and longer term plans.
Areas to Consider
It is also important to consider how deals are structured, to suit the current economic climate. We have seen an increase in the use of earn out clauses, which are often used to bridge the gap between buyer and seller expectations on valuation and to mitigate pricing risks in an uncertain economic climate . Dealsuite reported a significant increase in the number of times an earn out or vendor loan was applied in a transaction in H2-2022.
Earn out clauses can be structured in a variety of ways and are an effective mechanism to incentivise existing management to stay on and maximise the earning potential of the business, which in turn maximises their pay out.
Furthermore, if you are struggling to source the financing on day 1, these can be an effective method to allow for the business to pay for the acquisition itself.
We believe these mechanisms will become much more common going forward.
Structuring and timing of the payments and the underlying legal form of the agreement are vital to the success of this mechanism, whichever side you are on.
Reach out to the Transaction Services team, where we can have an initial discussion to determine your strategic objectives and how we can help you achieve them through a tailored approach.