The global effects of the pandemic have caused inevitable market pressures that will require industries to look towards reshaping the manner in which they carry on business, organically or through M&A. While 2020 may not have been the year of M&A mega deals, the pandemic that consumed 2020 has brought on a shift in both M&A activity in Canada and the structure of deals we anticipate to see in 2021.
Despite the unsurprising drop in M&A activity in the first half of 2020, the third quarter experienced a surge in deals. Several factors influenced this deal momentum, which we anticipate will persist and carry well into 2021:
- Distressed Companies: Distressed companies no longer have the benefit of government funding, temporary lender flexibility or other means of credit and may be more susceptible to opportunistic M&A or "fire-sales".
- Retail Uptake: M&A will likely be used as a means for companies to prepare for, and take advantage of, the foreseeable uptake in retail activity given the purported availability and wide spread distribution of vaccines, especially in Canada where the distribution of vaccines have commenced and the restrictions imposed on companies and retailers has been substantial.
- Restructuring Supply Chains: Disruptions in the supply chain caused by various restrictions, delays and cost of shipping, are motivating "vertical integration".
- Delayed Acquisitions: Companies that were considering M&A opportunities in 2020 may have had to put their plans on hold and are now looking to proceed in 2021. The deferred activity may have also led companies to seek out better valuations for targets they were previously considering in prior years.
- Low Interest Rates: Canadian buyers may see the Bank of Canada's low interest rates as an attractive opportunity for better loan conditions that ultimately lower the cost of acquisitions.
Despite the fact that certain industries, such as mining and commodities, which may have dominated the Canadian M&A market in 2019, may be more susceptible to "supply shocks" during a global financial or economic crisis, we expect to see an uptick in deal volume in other industries:
- Cybersecurity: Given the digitization of numerous business models (for instance, for remote working platforms), we anticipate more M&A deals with technology companies to protect businesses from cyber-security threats that could jeopardize their business.
- eCommerce: To further protect the businesses of digital companies, eCommerce platforms will likely be sought out by companies looking to join disruptive trends. In light of numerous government lockdowns across Canada, retailers in particular have a strong incentive to invest in eCommerce platforms to better position themselves to capitalize on the rising wave of online purchasing rather than bricks and mortar consumerism.
- Data-Mining: Acquisitions of data mining companies will further assist the retail industry maintain its competitiveness in the marketplace by tracking and servicing consumer trends.
Naturally, buyers have become increasingly concerned about the businesses of prospective acquisitions during these rather uncertain times. That said, we can expect that alternatives to payment arrangements and due diligence proceeds will likely permeate the traditional M&A structure in order to allow buyers to facilitate acquiring a business in 2021:
- Alternative Payment Mechanisms: A rise in alternatives to one-time cash purchases, such as earnouts and working capital adjustments, are appealing solutions to shield M&A deals in volatile markets. These payment structures help bridge any valuation disagreements between a buyer and seller by deferring part of the payment post-closing on the condition that certain targets are met. These tools are particularly useful where a buyer cannot assess whether a target's revenues and accounts are affected by the pandemic or whether there is an underlying issue inherent to the business itself. An increase in earnout provisions in M&A deals is not uncommon during periods of economic uncertainty. Indeed, it has been reported that the use of earnout provisions increased significantly in Canada during a period of depressed natural resource prices, compared to when the economy was relatively prosperous and stable.
- Alternative Due Diligence: We project a departure from traditional due diligence in light of COVID-19 restrictions where such restrictions make assessing and valuing target companies even more difficult. For example, virtual visits and drones will increasingly replace the need for on-site visits. In addition, as part of the due diligence process, buyers will want to better understand a target company's repayment obligations relating to COVID-related government assistance (e.g. Canadian Emergency Wage Subsidies), and adjusted insurance costs resulting from claims related to mandated lockdowns.
Lawyers are encouraged to monitor M&A activity as the pandemic has altered the landscape for M&A activity and structure that will carry over into, and well beyond, 2021. Indeed, despite the uncertainties experienced in 2020, we expect to see an uptick in M&A activity and creative structures to bridge the gap between parties, especially in those industries where the pandemic has presented opportunities for buyers or sellers alike.
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