At BDC, we finance thousands of business transfers every year. We work with SMEs of all sizes in all business sectors.
This significant level of activity gives us a good overview of the business transfer market in Canada.
Our economic research team also periodically conducts research to fully understand the dynamics of Canadian SME transfers.
Before the pandemic, for example, our studies showed that 50% of small business transfers planned to sell their business within the next five years. Since Canada has more than one million SMEs, this means that 500,000 SMEs could change owners by 2025.
My goal in this post is to explain that we understand the effects of the pandemic on the business transfers market in Canada and to share our tips for reducing the risks associated with an acquisition in the current climate.
The impact of the pandemic on business transfers in the United States
We do not yet know the long-term impact of the pandemic on the sale and purchase of businesses, but it is clear that the number of transactions has slowed in 2020. The crisis has also affected the sale price of businesses.
Here are examples of what we have seen in the market since March.
Some transactions have been canceled
You need to get an M&A advisor to get the job done. The acquirer, therefore, withdrew to concentrate on its own operations.
Some transactions have been suspended
The closing of borders seems to have had an impact on transactions. It does not prevent acquisitions, but it delays them.
For example, one of our clients was negotiating a major acquisition in the United States. The staff of the company in question had to self-isolate for two weeks after visiting the target company’s facilities. So they couldn’t go there anytime.
Some transactions have been accelerated
One of our customers in the manufacturing sector took advantage of the crisis to buy a small competitor who was trying to copy its model and steal market share from it business transfers. The competitor was not financially strong enough to survive the drop in volume caused by the pandemic.
We also see that many sellers want to sell at the pre-COVID price, while buyers want to take advantage of a lower price following the pandemic. This dynamic tends to block the progress of negotiations, thus reducing the total number of transactions. However, the pandemic is not making anyone any younger, and entrepreneurs eager to retire still are.
How do you navigate the current climate?
Don’t let the pandemic stop you. Entrepreneurs with sales plans shouldn’t put them on hold. The same for those who want to buy. Yes, you must do your homework, but there are even so many opportunities. As always, pandemic or not, it is better to acquire a company to which you, as a buyer, bring added value to make it grow and become better than it already is.
The quest for critical mass is essential. Two small businesses together will be stronger if they can share the growing expenses needed for IT lean strategy, implementing systems, or organizing a formal human resources department.
We, therefore, believe that the current climate is conducive to strategic acquisitions.
Consider a financial package that takes uncertainty into account
Uncertainty is the biggest enemy of business transfer. When you buy a business, you buy its future cash flows. If you go into debt to do so, you have, on the one hand, uncertain income, and cash flows, but on the other, fixed cash outflows for debt payments.
The pandemic has increased uncertainty around future cash flows for many businesses. So, you have to find a balance somewhere.
The solution is to convert fixed expenses into changing costs. You can perform this transformation in the financial package.
Over the past few months, we have helped our buyers to create financial arrangements in which the seller assumes a greater share of the financing, among other things with contingent considerations (earnout), which are payable according to the performance of the company. This is an option that serves to bridge the gap when both parties have difficulty agreeing on the outlook for the next few years, which is even more true in times of insecurity like a pandemic.
We find that seasoned entrepreneurs are turning to institutions that have a reputation for being stable and long-term. And are looking for longer-term repayable financing, with pay-as-you-go arrangements or whose repayment is conditional on business performance.
Watch out for temporary spikes in turnover
Many businesses have seen their profits increase due to the confinement (hardware stores, recreational vehicles, swimming pools, automobiles, renovations, etc.).
Assuming that this increase will be permanent in the context of an acquisition transaction could hurt twice rather than once: the company has just had an excellent year, inflated by confinement. Its profitability is therefore exaggerated, and we pay more to acquire it. In addition, these companies could fall back below the “normal” of 2019 for the next few years, as their customers may have lost their jobs or simply resumed their consumption habits.
In addition, many companies do not generate revenues before, but their financial statements do not reflect the decline in profitability since they have benefited from the support of governments. It is, therefore. Necessary to do substantive work to dissociate the effects of the pandemic from the true profitability of the company. Which can be reproduced, whether for a decrease or an increase in turnover.
We also suggest that you project yourself into the future and grasp how the market might evolve in the new reality. Keep in mind that the telecommuting trend is here to stay. Which will cause permanent changes in consumer behavior – for example. A drop in demand for smart clothes, or the questioning of the need for a second car or changing tires every three years. A rise in protectionism stemming from government policies to bolster state coffers and curry favor with pandemic-affected voters could also harm our exporters.
You will thus be able to have a realistic portrait of the financial situation of the company you want to acquire and pay the right price.
Telecommuting and culture: another challenge for mergers and acquisitions
Finally, the crisis has added a new, more devious risk for buyers.
When a business is sold, there is almost always a culture change through M&A advisory. Due to the rise of telecommuting, employees’ sense of belonging to the company is weakening. Informal interactions between people are rarer. Which makes it more difficult to take the pulse of employees and to send clear messages.
It will be more difficult to shape the culture that one wishes to establish after the transaction.
Human investment is the most valuable property you will obtain. But you will get less access to it during an epidemic.
An ecosystem ready to help you
The disaster has revealed to us the amazing strength of entrepreneurs. Many companies that were in growth mode were proactive lean management; they reviewed their cost structure and focused on efficiency or found new market niches.
These efforts will help create healthy companies that can become consolidators.
The broader investment community is now working to ensure these companies have the resources to continue growing.