Observations from the 27th Floor
President and CEO
How the pandemic has affected the value of your business is far from a straightforward question
What do the following businesses have in common?
- A manufacturer of specialty cleaning and related supplies
- A food delivery service
- A manufacturer of water-testing kits for swimming pools
- An automotive marketing company
- A manufacturer of air filtration equipment
Typically, the common thread among these diverse businesses would be hard to spot. Since the first quarter of last year, however, these businesses—along with many others—experienced dramatic financial swings due to the pandemic. Moreover, as the companies listed above were pursuing a sale transaction, they all had to determine how to frame their unexpected success or disappointing downturn for potential buyers—a task made all the more difficult by the unique circumstances of the last eighteen months.
Still, regardless of their particular experience during the pandemic and overall economic uncertainty, businesses are being bought and sold. In fact, the current M&A market is unusually strong for a variety of reasons. The pandemic’s effect on the value of an individual business is not always obvious, however.
The upshot: If sellers are to be paid appropriately for the underlying value of their companies, they must analyze and isolate the impact of the pandemic on the historical and projected financial performance of their business, then clearly communicate that analysis to buyers.
Consider the buyer’s perspective
With first-quarter 2021 M&A activity reaching $1.3 trillion, buyers are clearly interested and active. This scenario does not mean sellers can be complacent. A savvy buyer (and you should assume most buyers are savvy) will use a temporary dip in performance of an otherwise attractive business—for example, an automotive marketing company that had no business for three months when its dealership clients were closed—as a pretext to negotiate a discount in the upfront purchase price or to add contingent consideration to the deal.
Buyers will be equally skeptical about paying more for a business that saw rapid growth in a potentially abnormal and unsustainable market—like the maker of pool-cleaning test kits, which experienced unprecedented growth when summer travel was restricted and people directed much of their discretionary spending toward their homes.
From a seller’s perspective, this dynamic means it’s not enough to show up with solid historical results and hope for the best. (Without proper context, your financial statements may not tell a buyer the story you think they do.) Instead, sellers must be able to demonstrate the real underlying value of their business—both now and in the future. For this reason, we have found that bankers are spending much more time than usual assisting clients in analyzing and discussing the “story” behind the numbers.
How to tell an effective earnings story
While the pandemic’s effect on a business is rarely straightforward (since there are usually many internal and external factors affecting performance), there are some cases in which explaining that effect is relatively simple. If your business had to close during the early stages of lockdown, for example, you can simply present your financial statements on a pro forma basis excluding those months. This approach offers potential buyers a view of the company’s ongoing operations excluding the extraordinary situation. Likewise, if you had one-time expenses on personal protective equipment or overtime, noting those expenses and excluding them from the financial information should offer buyers a straightforward picture of the organization’s intrinsic operating margins.
Other changes are more complex—and require a lengthier explanation. For issues such as supply chain disruptions, high freight rates or an ongoing lack of available staff, sellers must provide a convincing narrative backed by industry analysis or other credible research to make the strongest possible case for these events being treated as non-recurring in nature and ultimately solvable.
In some cases, the story will hinge on whether pandemic-related changes are likely to persist. Consider our manufacturer of cleaning and related supplies above: one of its products is disposable gloves (latex and nitrile). A spike in sales due to new protective protocols during the pandemic will show up in the recent results, but a buyer will need to know whether those sales were a one-time phenomenon or whether the pandemic has resulted in lasting changes, such as opening the company to a new, broader market. To demonstrate a more permanent shift, the company might point out that it is now on the radar of new customers, some of whom will buy its other products after the pandemic, or that while sales increased, the results did not include revenue from food service customers who were largely shut down during the pandemic, but are now resuming their purchases. Sales data by customer that show a sustainable revenue run rate post-pandemic will help drive home the reality of an expanded customer base. Data identifying repeat purchases can be especially helpful in this regard.
For industries like our food-delivery service, part of the narrative might involve the notion that the pandemic has accelerated existing trends. The pandemic did not just force people to consider ordering restaurant food and having it delivered; it introduced consumers to the service’s convenience and encouraged restaurants to reconfigure their operations to better accommodate those services. Further strengthening that narrative, nearly seven in ten customers say they are more likely to turn to takeout or delivery since the pandemic. Documenting these trends can help make a case for underlying value that may not be readily apparent in the historical or current financial statements.
A clear picture helps buyers and sellers alike
It goes without saying that giving a buyer a clear and compelling picture of the value you have built in your business is critical for being paid appropriately in a sale. The pandemic-generated ups and downs in a company’s financial performance are not likely to be transparent to a potential buyer. They need to be explained in the broader context of the current run-rate activity of your business and the industry in which you operate. To make that context clear, it is important to remember that selling your company is a sales and marketing exercise. Being passive or trying to let the numbers speak for themselves is not enough. You must understand your story—and tell it convincingly.