Changes and Opportunities: Business and Estate Planning in the Wake of the Pandemic
by Bradley Williams
Based upon conversations that I’ve had with my clients who have been in the process of selling their business during these uncertain times, or who are considering selling soon, I’ve laid out 5 scenarios detailing what may have changed due to COVID-19, and how we can prepare for the environment that we now live in.
The world is unclear if we are in a buyer’s market, or still in a seller’s market.
Since 2010, the buyers of businesses, including competitors, private equity firms, and family offices, have been willing to pay a premium for businesses. That may not have changed, but the world is still not sure. We will still have cheap money, but businesses are more likely to shore up their balance sheet before going out and making any acquisitions. The buyers have not left the market completely, they seem to have asked for a “pause” to better understand this new landscape. At the Beringer Group, we are still currently receiving offers for businesses we represent, but the terms and details are more time dependent and beneficial to the buyer.
A bigger percentage of the total consideration has moved towards self-financing and an “earn out,” with cash taking the hit. This provides more certainty for the buyer and insurance that the acquiring firm continues to produce at negotiated levels. Private equity will always have to deploy investor capital, therefore deals are going to continue being made– but at what price for the seller is yet to be seen.
In response to the current situation, the banks are going to be more stringent with their lending. They will ask for higher covenants then they have in the past. The underwriting will be slower and more restrictive. The debt ratios will certainly not be as aggressive as they once were and the bank will ask for more liquidity.
What you can do: We always advise clients that they should to be prepared to sell their business in six months. Business owners should review and update their financial forecasting to show how they will be impacted by COVID-19. In order to differentiate yourself moving forward, a business owner should be able to answer how they responded to COVID-19, and how they would prepare for a similar pandemic in the future.
The due diligence process will certainly change moving forward.
Once a buyer and seller have agreed to the price and certain terms and agreements, the due diligence process starts. This includes a deep dive into your financials, employees, computer systems and technologies, hard and soft assets, etc. In the future, due diligence will include pandemic based continuity planning such as:
Does your company have a business continuity plan? Have your financials been stress tested?
How long can you sustain a certain level of underperformance? Can your employees work remotely?
What technologies do you have in place to shore up our seamless transition?
Do you have a teleconference technology that everyone understands how to use?
Is the technology that you use secure, and not able to be hacked?
Do you have business interruption insurance, or do you have self-funded cash reserves for a 3-6-9 month period?
What you can do: Be prepared now to go through a due diligence process. This will help you and your management look at the important factors that a buyer finds important. It will help not only you, but it will help your management understand what efficiencies increase the value of your business.
This is also a time to look at your corporate succession plan as this pandemic has caused us all to reflect and to understand that what was previously unimaginable can occur quickly. Buyers are going to be even more concerned with these plans if you, the business owner, are not at the helm. Prepare the next management team to understand what roles and responsibilities they will play if you were not in the picture.
After you review your plan, have an outside group also review your plan. Review with your board of directors or create a board of directors to help provide guidance. Create incentive plans for your key employees who have helped you through this current situation and have been strong contributors in the past. Have an outside firm do a “hit by the bus plan” for you and key contributors.
Purchase agreements will now include and address pandemics.
Purchase agreements previous to COVID-19 were concerned with inventory, assets, location, customers, customer concentration, EBITDA, sales, key personnel, etc. Moving forward these agreements will include impact of pandemics to your business. Buyers will have language in the purchase agreement that may allow them to walk away from a deal if there is an event similar to COVID-19. Investment bankers and deal lawyers will likely negotiate to reach a compromise between the buyer and the seller.
What you can do: Work with your lawyers and your business advisers to put together a process to prepare for such events and the language that you would feel comfortable in a purchase agreement for the sale of your business. You should also discuss with management and key personnel, the competitive advantages and the impact COVID-19 will have on your business versus your competition.
How a business will be sold will have a new normal.
Just as we thought we would never have a Zoom happy hour with friends, how we go about buying and selling a business is going to be different. In past years, the process included one on one meetings, site visits, formal management presentations, inventory reviews, contract negotiations, lunches and dinners. There will be a new normal now.
Given the fact that most business owners who are selling their business are an older demographic, they will be more concerned about exposing themselves to pathogens. Social distancing and video conferencing will be more prevalent in the future. There will certainly be less travel and due diligence tours, but deals may be done with less strain because putting together a meeting will become easier with video conferencing. It won’t replace face-to-face meetings, but it will speed up some of the initial fact-finding elements to the process.
What you can do: Be prepared to have video conferencing incorporated into your business to hold virtual meetings. Invest in a good camera and lighting elements to make you and your team look as impressive as you are. The benefit will allow you and your team to excel in these meetings and improve productivity.
Estate planning opportunities have arisen given lower valuations.
As a business owner, you recognize that there is always an opportunity in the market. The opportunity now stems from lower equity valuations, a low interest rate environment, and an estate tax exemption doubled from the previous 10 years. These factors create a significant estate planning opportunity.
This is especially important if you are planning to sell your business in the next five years as you can transfer shares out of your estate into the trust of a beneficiary of your choice. Additionally, the Cares Act has provided at least $3 trillion of aid to help stimulate the economy. It is our belief that we are going to have to pay that back through an increase in taxes or a reduction in estate tax exemption – or both.
What you can do: Review your current estate plan with advisers and determine the pros and cons of the tax planning opportunities that you have in this environment. Consider moving shares within your business to a trust and prepare for an increase in taxes moving forward.
Conclusion
America has quite possibly the best entrepreneurial culture in the world. Although COVID-19 has presented its share of problems, it has also brought ample opportunities to better position you and your business for the future. Now that you understand the environment and the dust is settling, engage with your advisers to understand the best steps to take to protect your business, employees, family, and wealth in light of this new information. There will never be a better time to optimize your estate planning and your business transition plan than the present.
About the Author
Bradley S. Williams
Brad has 15 years of experience in the investment banking industry. He has structured and executed a wide range of complex transactions, including corporate sales, acquisitions, mergers, joint ventures, recapitalizations, and leveraged buy-outs.