There is no way to dress it up and sugar coat things – calendar year 2024 was tough. High inflation leading to rising costs, reduced demand, high interest rates, high stock levels, slow paying debtors, tight working capital, difficult to raise extra funds and the list goes on. We saw the highest level of business insolvency events since the GFC and there are likely to be a lot more to come.
The message of “Survive to ‘25” was being touted everywhere – but we believe that things are going to get tougher before they improve and hence around the middle of ’24 we were telling everybody that simply surviving to ’25 was not good enough – you need a plan to survive through 2025.
Depressed yet? Fear not, read on…..
Crisis Breeds Opportunity
Yes, it has been a tough reset and yes there is more to come BUT our economy needed it. For too long we had been living of debt in an environment of falsely high levels of demand and an extremely tight labour market. We have now entered the natural cyclical nature of an economy, so we need to cut our cloth to make ends meet. Things will improve; it is just a matter of time.
With every crisis, lots of doors close – but many opportunities arise and doors open. You just need to be open to looking for them and be in the right mindset to tackle a project and create a competitive advantage.
The opportunities will arise in many different forms, including:
- Ability to trim costs and right size your organisation
- Renegotiate supply terms and pricing
- Speed up your working capital cycle
- Pick up business from competitors as they falter
- Renegotiate banking arrangements
- Acquire other businesses
Mergers and Acquisitions: A Key Opportunity for Growth
Mergers and acquisitions (M&A) have long been strategic avenues for growth in businesses worldwide, including New Zealand. Whether you're looking to expand market share, gain competitive advantage, or diversify products and services, M&A can provide transformative opportunities.
For the last decade M&A activity was high – particularly in the space that we advise in being the small to mid-market private companies – generally with an Enterprise Value of $3m to $50m. We saw valuations and multiples peaking during 2023 but sharply reduce in 2024. This reduction was driven by reduced risk appetite from acquirers and difficulty in funding transactions which narrowed the purchasing pool significantly.
We see 2025 being the year for M&A activity for mid-market businesses that have weathered the storm, have built resilience into the business and have the balance sheet to grow. Crisis creates opportunity – many of those businesses that simply survived to ’25 will now be running thin balance sheets and will not be able to fund the growth that comes as the year progresses. This means that they will need to make a move – and selling is a string option. With increased supply of business opportunities and weak demand from potential purchasers we are bound to see continued pressure on multiples which in turn creates an opportunity for a cashed-up buyer.
Proceed with Caution
Whilst we are excited about the opportunities that are undoubtedly coming through the pipeline (and we have already seen that pipeline growing), alongside these opportunities come complex financial and tax implications that must be navigated with care.
Prior to engaging in any process, we recommend conducting a robust strategic planning exercise and identifying exactly where and how you want to grow. This exercise should be very detailed – even getting down to compiling a list of acquisition targets that you are going to actively hunt – a bit of a wish list.
Once the list has been completed, be aware that those that are willing to sell are likely to have a reason for selling. It could be a genuine succession or health issue, but it could also be an under-performance issue. Worse still, it could be that the current owner sees the writing on the wall. Do not rule any businesses out – it simply comes down to being aware and working through what needs to be done to turn it around, support with additional capital or integrate into existing operations.
It all Comes Down to the Deal!
Here are our top 5 tips on negotiating the deal:
- Understand the Quality of Earnings
At the end of the day, the earnings need to be of a sufficient level and ongoing future quality in order to provide a return on your investment and create cash flow to repay any debt. Too often vendors focus on obtaining a high multiple of earnings, but if those earnings are inflated or minimal then no matter what the multiple is the business is unlikely to be worth as much as the vendor wants (or needs) from the transaction. We have seen many deals grind to a halt after a lot of wasted time (and money) as the earnings figures could not be agreed upon early enough.
Our number one focus is therefore to understand the underlying earnings, ensure those earnings will continue on into the future and to form a view on any normalisations that the vendor and seller's agent may have made in the Information Memorandum. - Identify the Risks
Early identification of the main risks will help us form a view on valuation, but nothing can replace a solid Due Diligence investigation. This is an insurance policy that you simply do not want to scrimp on! Things to consider are:
Financial Statements: Review the target company’s financial statements, including balance sheets, income statements, and cash flow statements. It’s important to verify the accuracy of these documents and ensure they comply with New Zealand financial reporting standards.
Outstanding Liabilities: Assess any debts, loans, or contingent liabilities that may impact the financial stability of the target company. This includes tax obligations, unpaid invoices, and any legal disputes.
Contracts and Agreements: Analyse the company’s contracts with suppliers, clients, and employees. Are there any long-term contracts that may affect future profitability? Are there any restrictive agreements or warranties that could hinder future growth?
Tax Compliance: Ensure that the target company is compliant with New Zealand tax laws, including GST, corporate tax, and PAYE obligations. Non-compliance could result in significant financial penalties.
Failing to properly assess these areas could result in unforeseen financial challenges down the line, potentially reducing the value of the merger or acquisition. - Evaluate the Opportunities and Synergies
A key motivation for mergers and acquisitions is the ability to realise synergies—cost savings or revenue enhancements that arise from the combined operations of two businesses. However, not all synergies are realised immediately, and understanding the financial impact of integration is crucial.
Cost Synergies: Cost synergies often arise from eliminating duplicate functions, such as administrative roles or IT systems, and achieving economies of scale in purchasing or production. For example, merging two companies may allow you to negotiate better terms with suppliers due to increased purchasing power.
Revenue Synergies: Revenue synergies come from increased sales opportunities as a result of the merger or acquisition. This could involve cross-selling products to the combined customer base, entering new markets, or leveraging a stronger brand presence.
Integration Costs: While synergies can provide significant financial benefits, it’s important to account for the costs of integration. Merging two businesses requires investment in IT systems, staff training, and sometimes severance packages for redundant employees. These costs can temporarily reduce cash flow and must be factored into the financial planning process.
A detailed analysis of expected synergies and integration costs before proceeding with a merger or acquisition will help you create a realistic financial model and avoid overestimating the benefits. - Get the Deal Structure Right
One of the main tax considerations in M&A transactions is how the purchase is structured. In New Zealand, businesses can structure acquisitions either as an asset purchase or a share purchase, and each has different tax consequences.
Asset Purchase: In an asset purchase, the acquiring company buys the assets of the target company rather than its shares. The advantage of this structure is that it allows the buyer to "cherry-pick" the assets they want and avoid any unwanted liabilities. However, the target company may be subject to tax on the sale of assets, and this could influence the final price of the transaction.
Share Purchase: In a share purchase, the buyer acquires the target company’s shares, including all of its assets and liabilities. This structure can provide a smoother transition but may expose the buyer to hidden liabilities, such as outstanding tax obligations or legal disputes.
Deal structures also need to contemplate how and when you will pay for the business – for example as a purchaser we are strongly advocating for an earn-out component. This means that a portiuon of the price is based on the business achieving certain goals and milestones over the next two to three years and is only paid if the business achieves these goals. - Understand your financial ability to complete the deal
Financing is another critical consideration in M&A activity. Whether you’re the buyer or the seller, understanding the financing options available and their implications is crucial to a successful transaction. Prior to commencing any M&A activity with a client, we will run your business through our debt capacity financial modelling program to identify the additional debt that you are able to take on. Once a target has been identified, we will also run the target business through a more conservative debt capacity model to see what financing options are available on the target business alone. The combination of the two numbers shows the maximum level of debt that we believe the merged entity could comfortably manage and the mainstream banks would be prepared to lend against.
Navigating M&A with Confidence
Mergers and acquisitions offer exciting opportunities for growth, but they also come with significant financial and tax considerations. By conducting thorough due diligence, understanding the tax implications, carefully selecting a financing option, and planning for post-merger integration, businesses can position themselves for long-term success. There is a window of opportunity opening – make sure you are ready to take advantage.
At Bellingham Wallace, we have extensive experience guiding New Zealand businesses through the complexities of mergers and acquisitions. Our team of experts is here to provide tailored advice on every aspect of the process. Contact us today to discuss how we can support your M&A strategy and help your business grow.
Author - Matt Bellingham
