Just a few months ago, in our February 2020 Five Under 5,
we talked about how the annual growth in overall private M&A
deal value showed no signs of tapering off. How quickly things
changed. The emergence of COVID-19 has resulted in a material
slowdown in the Canadian private M&A market in Q2 2020. Parties
are still transacting, but the pace and volume have clearly
declined as buyers have focused on supporting their existing
businesses, and sellers have taken a step back from pursuing their
sales processes as they wait optimistically for some stabilization,
if not recovery, in the market.
As Canadian jurisdictions are embarking on the initial phases of
the economic reopening, we wanted to share some trends that we will
be closely watching in the weeks and months ahead that may impact
your business. For more on the Canadian private M&A market,
tune into
Episode 6 of the Blakes Continuity podcast, where we
discuss these and other trends in the market today.
- U.S. Investors: As has been well documented, U.S. private equity funds have a vast pool of dry powder that is just waiting to be deployed—far greater than that available to Canadian private equity funds. In our deal database (from which we pull the data for our Canadian Private Equity Deal Study), the prevalence of U.S.-based buyers has increased in each of the last three years. As the markets settle and deal activity starts to pick up, it will be interesting to see if the race to source deals and deploy capital results in a further uptick in U.S. investment into Canada.
- Diligence: We are already seeing, and expect to continue to see, heightened focus on business, financial and legal due diligence, particularly in respect of new COVID-19-related inquiries. Buyers are keen to understand how well targets have withstood the current shutdown, how their supply chains have fared, how their demand-side prospects have been impacted and how well positioned the targets are to withstand the potential consequences of a second or even third wave of infections. Proactive sellers bringing their deals to market in the near term should anticipate, gather and prepare this information in advance to facilitate a speedy due diligence process and avoid letting their sales process drag on unnecessarily, and run the risk of having new adverse events impact their sales process.
- Earnouts: A seldom-used mechanism in the M&A tool kit (only 12 per cent of deals in the second edition of the Blakes Canadian Private Equity Deal Study) has found new life in recent months. Valuations are a point of contention between buyer and seller at the best of times, and finding common ground is made infinitely more complicated when the economic outlook is uncertain and prone to widely varying forecasts. The "sellers' market" of recent years had been pushing transactions towards "clean" or "near-clean" exits. Conversely, earnouts, which force a buyer and seller to both have a vested interest in the post-transaction operations of the target business, are largely incompatible with such exits. That said, in the face of significant valuation gaps between buyers and sellers, earnouts offer a way to help the parties bridge the gap and ultimately strike a deal. As a result, we expect to see an increasing prevalence of earnouts in the near and medium term until the economic outlook is less susceptible to fluctuations.
- Financing: In the context of the current uncertainty, not surprisingly, debt financing is not as readily available as it was a few months ago. Consequently, we will likely see more structured and creative financing plans from buyers (and, in some cases, in collaboration with sellers) in order to fund the acquisitions.
- Consolidations: Prior to the emergence of COVID-19, we were expecting consolidation and contraction in the cannabis industry, but the stresses resulting from the pandemic have likely only accelerated the timeline of this consolidation activity. Similarly, we anticipate consolidation and roll-up acquisition strategies in the health-care sector as individual practitioners find increased attractiveness in the security offered by participation in a larger, multi-site practice platform.
Originally published 25 May 2020
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