What would an economic downturn mean for tech M&A activity, and how should buyers and sellers prepare for the cycle ahead? – Marketing
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Starting with a sell-off in public tech stocks (“FAMMGA” trading is no longer a winning strategy), the outbreak of war in Europe, the upcoming midterm elections in the United States, inflation out of control, rapidly rising interest rates, revolving COVID19 shutdown – outages in China impacting supply chain, rising prices at the pump, threats of war in the Taiwan Straits and the increased regulation by law enforcement, all while the world has otherwise seen a return to “real life” activity after two years with minimal in-person events, has had far-reaching effects , from gas station to grocery store, capital markets and technology M&A activities.
We’ve already looked at how the volatile events of 2022 negatively impacted tech startup valuations and venture capital investments, but how does this affect tech M&A activity? Common sense would tell us that with falling tech valuations, tech acquisitions would be on the rise. But is this really the case?
A recent analysis by Jahani & Associates took an in-depth look at the impact of the economic downturn on mergers and acquisitions and whether it actually led to a spike in activity. What they found was significant growth in global M&A deals in terms of capital deployed in the first half of this year – a 67% increase over the same period last year (from 1 .14 trillion to $1.91 trillion). They point out that we don’t yet understand the full effects of a recession (it’s generally accepted that the US has only been officially in a recession since the summer of 2022), but their data shows that companies have taken advantage of these valuations. weaker and use 2021 profits to make acquisitions.
Here are some of the additional highlights from their report:
- Median deal size increased from $19 million and $24 million in the first and second quarters of 2021, respectively, to $31 million and $43 million in the first and second quarters of 2022, respectively.
- This highlights an increased appetite for acquisitions despite economic downturns, as deployment strategies become increasingly aggressive, resulting in larger deal sizes. Tough trading conditions would boost demand on the supply side, while a lower valuation would lead to increased demand for acquisitions.
- Capital deployed in cross-border M&A transactions by U.S.-based companies increased 59% between the first half of 2021 ($69 billion) and the second half of 2022 ($169 billion). The number of deals increased steadily by 13% between the first half of 2021 (706 M&A deals) and the first half of 2022 (813 M&A deals).
- The data suggests significant growth in cross-border M&A activity by US-based companies. The degree of competition in domestic markets as well as more affordable valuations in international markets will continue to drive future cross-border transactions.
However, a closer look at M&A activity in the technology sector reveals a different story. According to data drawn from S&P Capital IQ, Pitchbook and MergerMarket, overall tech M&A activity fell more than 40% to around $450 million in the nine months ended September 30, 2022. And that despite some blockbuster deals like Adobe’s $20 billion acquisition FIGMA and some big private equity buys.
But there are reasons for optimism as we look at the post-election cycle:
- Regardless of who wins the midterm elections, controlling inflation and more thoughtful regulation should become the priorities of the new Congress, and regulators should move towards activating rather than blocking digital assets, of Web3 and new capital formation.
- As inflation declines, interest rates should stabilize, making acquisition financing more predictable.
- Dry powder has accumulated to historic levels within private equity funds, public companies and SPACs, and investors will look to take advantage of better times to get those funds working.
- Private equity firms that have been waiting for better funding and other terms should pull their best-performing assets off the top shelves and bring them to market.
- Sellers who waited for better days will capitulate, and clearing the backlog should lead to good deals for strategic and financial buyers
- We expect buyers and sellers to structure acquisitions with working capital / equity consideration to provide selling shareholders with an advantage (note that unless these shares are publicly traded, there may be there is no way available for selling shareholders to collect their equity).
We are already seeing sellers offering seller financing to buyers to maintain the valuation line in the face of a significantly higher cost of capital in capital markets. We expect private equity buyers to increase their use of liquidation preferences at multiples greater than 1x, participation rights, in-kind dividends and forced redemption features to bridge valuation and price gaps. risk. We are seeing more and more structures of price supplements and deferred payments to protect the capital invested but also the expected return on the capital invested.
The impact of hot war, cold war, geopolitical instability, another pandemic outbreak or natural disaster can never be predicted, but there are reasons for optimism. To prepare for a quick start in 2023, we expect buyers and sellers to do their best by:
- Reduce spending within portfolio companies and secure additional bridge financing (whether equity or debt) to create an 18-month cash trail.
- Identify and cultivate business relationships with potential buyers and targets to mitigate risk.
- Build target pipelines through top-down strategic targeting and bottom-up opportunistic leads.
- Doing more detailed prep work before initiating a two-way process, such as building a modernized valuation model that takes into account new market conditions, showing profitability in addition to growth, readiness to a virtual data room, scenario planning to answer difficult due diligence questions, advanced ‘earnings quality’ reviews, and more 360-degree consultations with potential counterparties and ecosystem parties.
From a legal perspective, part of this prep work should include a detailed review of your company’s revenue and business arrangements:
- Investigate whether contracts can be extended in a simplified way, automatically and for long periods.
- Removed the ability to terminate for convenience.
- Update Force Majeure and Material Adverse Effects provisions to ensure sources of recent volatility and potential future sources on the horizon will protect you from liability.
- Ensure that the covenants contained therein (if any) are not disproportionately burdensome.
- Structure revenue as a subscription with seat licenses limited in scope.
- Verification of compliance with existing subscription contracts, recovery of past charges and negotiation of future charges.
- Extend debt maturities, secure new confirmed lines of credit of all types.
All of this requires strategy, good planning and forward-thinking, proactive advisors who are all involved.
No one can predict with certainty the lasting effects of an economic downturn and whether tech M&A activity will fluctuate or recede. We continue to see economic conditions evolve daily. However, current economic conditions present the ideal M&A market for buyers. So in 2023, we may continue to see an increased appetite for acquisitions as valuations stabilize at lower levels, inflation declines and interest rates decline.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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