Look - I knew the companies that sold puzzles, hand sanitizer, and masks were not going to be valued at their peak COVID levels and thankfully, so did most of those business owners.  Those COVID-related sales and profitability increases were positive impacts on a business that had a very "one-timey" feel to them.

On the other hand, there were certainly businesses that had one-time negative impacts in 2020 due to shipping issues or shutdowns.  We all read about those or saw them on the news.  In my valuation world, those can be pretty easy to adjust back to normalcy by looking at previous years' margins or some other investment banking math wizardry.  

The real trouble began when businesses got through 2020 and the first half of 2021 just fine.  Or, heaven forbid, grew a little bit.  This is the situation, surprisingly, that has buyers seriously shook.

If a company did just fine through the pandemic it could be because they had what buyers are calling a "COVID bump" - a positive impact from COVID, albeit not as positive as the puzzle or the hand sanitizer companies.  Think of the companies that make coffee makers. 

People spent more time at home.  People decided they wanted to make coffee.  People bought coffee makers in record numbers.  More people decide they love coffee.  They join coffee groups on Facebook.  They have home offices now so they are going to drink coffee at home for the foreseeable future.

So now, let's say the coffee maker company is for sale.  How much of the increase in sales and profitability was a COVID bump?  How much will remain?  You could certainly make an argument that people's newfound fascination with coffee could linger well past the pandemic and this new caffeine craze could last a long time. 

Sellers, of course, will make the argument that this bean-fueled peak performance is the new normal and that buyers should value them at this level.  Buyers are understandably cautious, but given that we are in an extremely aggressive market from a valuation perspective, they are being forced to be creative.

Here are some possible answers:

1) Wait

Obviously not everyone's favorite answer to the problem but in many ways, time will tell us more of the long-term COVID story.  This has gotten increasingly more subtle such that a company that has just done well through the pandemic might see buyers looking for quarterly results as they go through the sale process.  As a merger and acquisition advisor, we generally dislike waiting because it adds transaction risk to a process (examples of M&A transaction risk:  what if your best customer leaves?, what if your plant blows up?, what if the market tanks? There is a long list of horribles I could come up with). BUT - right now in the fall of 2021, it might be the only time in my career that I will tell you that it may make sense to wait a quarter or two if you have a business that had what buyers are perceiving as a COVID bump and can continue to perform well.  The value you will receive by showing the buyers that you can continue to deliver results will be material and should outweigh any short-term risks.  

2) Contingent Consideration

Generally, I am also not a fan of contingent consideration, however, if a seller is not in a position to wait, this is a situation where an earnout or another contingent structure where a seller is paid for future sales or profitability makes perfect sense.  In this case, a seller is paid a base amount (the agreed-upon "non-COVID number") and then should be paid an amount for every sales or profitability dollar delivered above that amount for some future time period.  This rewards the seller for any lingering performance above and beyond the perceived one-time bump that the buyer was trying to avoid.  

This situation and the sourdough bread are just a couple of the things I did not see coming as a result of COVID.  We are seeing a number of clients in a wide range of industries - some in absolutely non-consumer-facing spaces - where we are questioning their profitability and performance in 2021.  Of course, not all of these businesses will receive the same level of buyer scrutiny, but it is certainly on the diligence checklists of the future.

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