Why distressed M&A is front of mind for dealmakers

Deal climates that marked by uncertainty force dealmakers to adapt – and in many cases put transactional activity on hold. But despite the long-term impacts of the post-pandemic landscape, the fundamentals of mergers and acquisitions as a means to boost value and growth are not likely to change.
 
Negotiations and risk assessment will continue in this environment, albeit with renewed emphasis on in-depth due diligence processes and built-in adjustment mechanisms for valuation.
 
Private equity investors have plenty of capital and are actively seeking out ways to invest in this climate. It’s anticipated that PE activity will be among the fastest to return post-COVID, with early signs showing that "dealmakers are now operating in a buyer’s market" (JD Supra).
 
The scene is set for investors, funds and buyers to acquire distressed assets and companies – and signs show they are already getting started. Our early indicators data shows an increase of 43% in new M&A deals commencing last quarter (July - September 2020), compared to the previous quarter, where M&A activity was down 25%.

What is distressed M&A?

Distressed M&A covers mergers and acquisitions of companies that are operating under financial distress. These M&A targets may be at risk of bankruptcy or insolvency, or struggling to meet its financial obligations or maintain sufficient liquidity.

Distressed M&A deals often involve highly motivated target companies - who are looking to pay off debts, avoid bankruptcy or wind down operations - and are often time-sensitive deals that are executed quickly. Deals that involve financial distress can be high-risk, but potentially highly advantageous for the companies involved.
 

Significant events like COVID can lead to more distressed M&A

Even from its early days, the pandemic was expected to leave a number of distressed companies who need buyers or investors in its wake.

"With depressed valuations and significant pockets of cash available to investors, there are likely to be many M&A opportunities that might be classed as 'distressed M&A'," according to Baker McKenzie.
 
While the key differentiator is financial distress, the levels of distress could vary considerably from company to company. While some may be proactively anticipating cash flow issues moving forward, others may already be looking at formal restructuring or insolvency options. All transactions that fall on this spectrum could be considered distressed M&A.
 

Reaching the tipping point

Governments the world over have made amendments to their insolvency laws in order to buy companies more time in order to ride out the impact of the pandemic – but these measures are temporary, and in many cases, delaying the inevitable. If a company has not managed to redefine and reshape its business model to fit ‘the new normal’, these temporary measures will do little to keep them afloat in a post-COVID world.
 
"With the actions many companies have been taking to shore up their balance sheets, to restructure and to preserve cash, we are not yet at the tipping point at which we will see a sudden rise in distressed M&A situations but that is expected to change’’ (Baker McKenzie).

What is clear is that the government cannot prop up distressed companies indefinitely. And when that tipping point is reached, we anticipate a flurry of M&A opportunities. The next 3-4 months will be critical to watch - a sentiment shared by the majority of leading dealmakers.
 

What can buyers do now to prepare?

“A distressed M&A process tends to be an imperfect one - characterised by a compressed timetable, limited information available to a buyer and invariably more limited contractual protection for buyers. As such buyers need to be well prepared, with experienced advisers, and they must be ready to act (and react) quickly.” (Baker McKenzie)
 
Depending on the severity of the company in distress, there may be limited time or information for a thorough due diligence process. This makes it critical for buyers to prioritize the most important issues and adopt a standardized process across acquisitions in order to seize on the opportunities while mitigating the risks.

For those who are prepared, the rewards significantly outweigh the risks. Accelerated deal timelines along with discounted prices will continue to make distressed assets and companies highly attractive options for buyers.
 
We’ve developed a Targeted Acquisition checklist so that you can maximize value in challenging and time critical situations, and evaluate and assess targets at scale. Now you can ensure efficient, secure acquisition processes with maximum visibility and minimal risk.