Despite the challenging environment, there are tremendous opportunities to be had.
Like every other aspect of business in 2020, supporting transactions in the AEC industry during COVID-19 has been cause for creativity and an outlet for those who really embrace change and lean in to chaos. While that’s perhaps a bit dramatic, keeping mergers and acquisitions on track has required strategic thinking that applies to other aspects of business.
Many firms have put their M&A activity completely on hold, as the challenges of running a company have required undivided attention. This presents tremendous opportunity for those firms that have the capacity to initiate M&A discussions. Not only are firm leaders – the targets for potential buyers – receiving fewer inquiries, but they’re also working from home, or at least six feet away from their nearest colleague, opening the door for more candid and open conversation. Initiating new conversations during COVID can be hard without the benefit of a warm lead or intermediary to make an introduction, but this could also be a great time to reestablish a connection with “the one that got away” – it’s safe to say that circumstances have changed for everyone in this environment.
Much of my line of work is really focused on nurturing relationships in support of executing the strategies of would-be buyers or sellers. In that capacity, I would also observe that would-be buyers and sellers who are holding off on their dealmaking activity are missing a unique time for a different type of courtship. The emotional intelligence required to build a connection and gauge compatibility over a series of calls and videoconferences is remarkable. In fact, in some respects, I would say it is easier to build genuine relationships. It is inherently humanizing to meet with an executive over a videoconference from their home. I was on a negotiation call recently – the type of thing that required an obligatory steak dinner in the Old Days – when a revenue projection discussion was interrupted by a 4-year-old demanding her father stand by his commitment to color with her. The kind of access available with this lessening of formality is truly remarkable.
Further, if the buyer and seller are operating in different geographic locations, the increased reliance on virtual communication can provide much more realistic assessments of what it would be like to work together after the transaction closes and the type of polished, in-person meetings are replaced by the mundane day-to-day emails and calls.
Building a strong relationship isn’t just helpful for integration planning, it’s also foundational for the type of due diligence that is taking place this year. Conducting due diligence remotely is tough, and it’s realistic to plan for a more extended timeframe than your firm may be accustomed to as a result. Even in the friendliest of transactions, due diligence is inherently stressful. Add that to the pressure-cooker of a year that 2020 has been, and the only thing that will keep a transaction on track is the sheer will of the parties involved, which requires one critical ingredient: authentic trust. As an aside, due diligence this year needs to deviate from the template to incorporate conversations about employment liabilities earlier in the process (such as off-balance sheet PTO accruals), analysis of PPP loan proceeds and loan documents, and increased emphasis on free cash flow over typical adjusted EBITDA analysis.
As negotiations proceed to deal structuring, the current climate presents an occasion to re-assess your financing strategy. Every firm is in cash conservation right now, as concerns over working capital remain appropriately top of mind. Several buyers we work with are considering deploying their equity as consideration to minimize their cash outlay, meaning paying for the firm they are acquiring by using the buyer’s stock as part of the payment. There are plenty of reasons that equity can be fantastic “currency,” sure, but your deal team would be wise to avoid a myopic focus on conserving cash that goes straight to the most expensive capital that there is for most AEC firms: ownership.
The median return on equity last year in the AEC industry according to Zweig Group’s 2020 Financial Performance Survey was 54.4 percent (pre-tax, pre-bonus). Equity is expensive capital – especially if your firm is in growth mode. I actually had one CEO tell me that they prefer using stock ownership to finance transactions over debt because taking on debt “hurts their valuation” (begging the question “valuation of what?”). Rather than either cash or equity, consider third-party interest-bearing debt. It is unfortunate that debt aversion is almost debilitating for many firms in our industry, especially when interest rates remain very low.
Despite the challenging environment, there are tremendous opportunities to be had, whether the time is right to close a transaction or to invest in building a long-term relationship that may eventually turn into a partnership.
Jamie Claire Kiser is managing principal and director of advisory services at Zweig Group. Contact her at jkiser@zweiggroup.com.
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