Considering M&A? Eight ways to navigate uncertainty

Three prime ministers, inflation, rising interest rates, Brexit, a pandemic, geopolitics, a skills shortage... it's no surprise that ‘permacrisis’ was Collins Dictionary’s 2022 word of the year.

In this extended period of instability and insecurity, what's the current state of the M&A market?

That's the question we posed at our recent corporate M&A community dinner to an expert panel comprising:

• Sally McKone, CFO, Focusrite plc
• Tracey Huggett, Managing Partner, Future Business Partnership
• Peter Gordon, Director of M&A, Learning Technologies Group plc
• Andy Morgan, Head of TMT, Corporate Finance Advisory, Grant Thornton UK LLP

From the discussion we've highlighted eight key factors to bear in mind if you're considering M&A.

1 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, as seen in the recent collapse of UK retailers Made.com and Joules. 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.

2 Be realistic on 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.

3 Earnouts are essential

There was a consensus among panel members that earnout structures were a core part of their preferred deal structure for three key reasons:

• They mitigate valuation disputes and help bridge any price expectations gap
• Amid a skills shortage, they ensure that key employees remain within the acquired business
• They can reduce the risk incurred by an acquirer, particularly in a turbulent economic market

However, when negotiating an earn out, it's also important to invest time in structuring the mechanism to ensure you are incentivising favourable behaviours.

4 Don't make assumptions about consumer behaviour

Whether your 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. More than ever, due diligence must include thorough research into end-customer dynamics.

5 Leverage your specialism

Though specialist investors aren't as well insulated as generalists during a downturn, this can be a strength. Investors with in-depth sector knowledge and strong operational capability on their board can respond quickly to opportunities while generalist competitors are still weighing up risk.

6 Factor the labour market into M&A due diligence

Headline layoffs at the world’s biggest tech companies suggest that the labour pool is growing, at least for mid-skilled workers in the US. The UK, however, faces a shortage of workers in various sectors. 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.

7 Consider the FX impact

A strong US dollar – in comparison to sterling and the euro – will likely result in an influx of US buyers targeting UK companies, creating competition for UK acquirers. Given current macroeconomic instability, foreign exchange (FX) exposures are likely to continue to be an important part of the diligence process.

8 Focus on core M&A strategy

Our view is that the successful legacy of deals struck during the turmoil of the pandemic and in the aftermath of the 2008 financial crisis proves that 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 ensure that you exploit the right market opportunities. You can achieve this while also minimising risk, delivering a business plan and ensuring shareholder value is maximised. 

For further information on navigating M&A in uncertain times, contact Sam King.