Acquisitions or Alliances: What's Your Growth Strategy?

As more Americans become vaccinated against COVID-19, the long months of pandemic uncertainty are expected to end. Meanwhile, businesses are looking to mergers and acquisitions (M&A) as a key strategy for moving past the turbulent year and for securing success in 2021 and beyond.

"With the pandemic, there seems to be light at the end of the tunnel now, and we're at a much different place than we were a year ago," said Zachary Chubb, managing director of the food and beverage group at City National. “At the end of 2020, clients had a much better handle on the impact of COVID, where their businesses stood and the opportunities ahead. Many of them had shifted their focus from preparing for and managing the impact of COVID and onto positioning themselves to capitalize on the new normal."

Today, positioning yourself for “the new normal" could mean acquiring or collaborating with other firms in order to attain competencies that the post-pandemic market demands. For example, in the food and beverage industry, the new normal includes new levels of digital adaptation, direct-to-consumer products and a focus on health and wellness, Chubb said.

Throughout 2021, Chubb and other experts expect to see continued strong M&A activity as a result. In response to the lifting of pandemic restrictions and financing availability, “we are currently in one of the longest M&A cycles we've experienced," said Vito Sperduto, managing director and co-head of Global Mergers and Acquisitions at RBC Capital Markets.

And as this trend continues, business leaders who are interested in acquiring, merging or being acquired will be more successful if they understand the current market and how to position their companies for successful M&A transactions.

What's driving the trend?

There are a number of financial reasons why companies are considering mergers and acquisitions.

First of all, companies have more cash on hand now, Sperduto said.

“After the 2008-2009 financial crisis, companies started hoarding cash," he explained. “Cash on balance sheets has been at record levels each year since the financial crisis, and, as a result, companies have built up significant stockpiles of cash. In fact, cash on balance sheets of the S&P 500 has more than doubled since the financial crisis."

In addition, private equity (PE) firms have high levels of dry-powder available (raised, but unspent, cash). “They get paid to make investments, not to hold cash," Sperduto said. “Those dollars need to be spent, so they're looking for opportunities."

Finally, the financing market is providing funding at pre-pandemic levels, the equity markets are strong and decision makers are feeling confident in the future of their companies in 2021.

“The average CEO of a public company has been in that seat for nine or more years," Sperduto said. “They have built up trust with the board and have built confidence in their ability to make decisions. They have a grasp of the market and a grasp of their business. There's a light at the end of the tunnel with COVID, and people are confident there will be a reopening, and in some cases the reopening is happening now. But they've also gotten confident doing business remotely."

The conditions are very supportive for M&A, agreed Chubb. "It's a very active M&A environment right now."

But should you jump on board?

Though M&A is trending, not every opportunity is right for every company. While business leaders expect to see strong acquisition activity throughout 2021, a better choice for some companies' growth goals may be forming an alliance or partnership with another company.

For others, simply staying the course and growing organically is ideal.

"A merger or acquisition is generally an accretive growth strategy for companies looking to drive innovation quickly and increase scale," Chubb explained. "Creating a partnership, on the other hand, allows the two businesses to collaborate before making a committed step forward."

To determine which growth strategy is best for your company, figure out what your customers want and need, Chubb advised.

From there, decide whether you could meet that demand more effectively with a partner, through an acquisition or through augmenting existing capabilities internally. Determining whether to pursue growth through an acquisition or merger depends on your goals, risk tolerance, and the financial implications, Chubb said.

Through a partnership, companies may not get the full financial or operating benefit of an acquisition right away, "but you do get the chance to leverage and benefit from each other's capabilities," he said.

Tips for Purchasers

Acquiring a business in 2021 may look different from a few years ago. The virtual environment forced by the pandemic, for instance, has caused an incredible amount of acceleration across multiple different business trends.

“We have seen that those businesses that are well-positioned and resilient are able to quickly adapt, regardless of whether employees are working at home or on site," Sperduto said. "With this said, now may be a good time to revisit deals you've considered over the years to see how the pandemic has changed things."

If you're looking to make an acquisition in the near future, there are a few tips to keep in mind, including:

• Preparing in advance. An important initial step in acquiring another business is proactively prepare strategically and financially to make a move verses trying to chase a situation when an opportunity arises. “A potentially good buyer who has not prepared in advance may lose out others who are prepared, have conviction to pay a premium price and are able to move quickly." Chubb said.

• Taking time to understand the target. In addition to being prepared for an acquisition, business leaders who truly understand the target business, including how it will fit into their current business and how to realize operational and financial synergies, will be more successful, Chubb said.

• Expecting that cultural aspects will largely remain in place. Sperduto recommended focusing not only on the financial performance of the business you're buying, but also on the employees, shareholders and the social and governance issues involved with that business. The focus on EESG (Employees, Environment, Social and Governance) has become increasingly important, and “you can't assume you'll be able to change these features," Sperduto said. “You need to understand those components of the company. Alignment on EESG factors contributes more than ever to successful post acquisition integration and performance."

• Considering the market conditions, but not undertaking an acquisition just because of them. The conditions may be ripe for M&A activity, but that doesn't mean M&A activity is right for every business. “There are market considerations, and there are individual company considerations," Sperduto explained. “Good, strategic M&A transactions get done regardless of the market. We always can figure out how to structure it and how to finance it, but it has to make sense for what you're trying to do."

Good deals that have a strong, strategic rationale are the ones that are successful, said Sperduto. Whether an acquisition is right tends to depend on the industry and how the company is positioned within the industry.

Tips for sellers

As the population ages and looks to retire, many business owners are starting to consider different strategies for selling their business. And 2021, with financing widely available, may be a good time to seek a buyer.

“If your business is a leader in an industry vertical, it has probably been afforded a huge increase in valuation," Sperduto said. “Many business owners are looking at M&A to solidify that position, while others are looking at M&A as a way to bolster their position. On the other hand, some may decide that M&A is their exit and a better option than continuing to run their business."

If you're looking to sell your business in the near future, there are a few tips to keep in mind, including:

• Starting early. “We recommend looking for a buyer a few years in advance," said Nuri Benturk, head of Corporate and Executive Services at RBC Wealth Management, who works with many business owner clients on M&A transactions. “Don't start the dialogue when you're ready to retire."

Often, there are extenuating circumstances pushing owners to sell, such as a divorce or health issues. By waiting until circumstances demand a quick sale, many business owners miss the chance to truly get what their business is worth.

Another reason to start early is that a potential buyer may want the business owner to stay on board for a few years after closing the deal, so immediate retirement won't be possible.

• Talking to investment bankers. One mistake business owners make is trying to sell the business without expert help. “Most owners are biased when it comes to valuation. They have spent their entire lives building a business, and there's a disconnect between what they think the business is worth and what a buyer will pay. Regardless, the owner, in many cases, has never gotten a valuation," Benturk said.

• Pursuing competing bids. The best way to find out the true value of your business is to get multiple competitive bids. Frequently, a business owner will hear from a competitor who wants to buy their business, or from a private equity firm who knocked on their door and wants to buy, and they consider just the one price, Benturk said. "But with one price, you never get the real value."

Benturk has worked with many companies that, unfortunately, received high offers from private equity firms only to watch those offers drop or disappear once the PE firm takes a look at their confidential information.

“Many times, they were not really there to buy the business, just to learn about it," he said. "Instead of settling for the first offer, it's important to take time to generate several competing offers."

• Considering alternatives. With so many business owners nearing retirement, many traditional companies simply don't find a lot of interested buyers, Benturk said. In that case, he recommended owners consider creating an ESOP (Employee Stock Ownership Plan).

With an ESOP, you sell the company back to the qualified plan and employees are the beneficiaries of the qualified plan.

“We're seeing more and more ESOPs," Benturk said. “Business owners may not want a PE company coming in and firing employees they've had for 30 or 40 years. An ESOP creates continuity for employees and creates tax benefits for the owner."

To keep up-to-date with the latest economic perspectives and shifting global markets, sign up for City National Bank's newsletters here. Delivered biweekly, straight to your inbox.