Take advantage of the changing shape and form of the deal

There have been an increasing number of companies in financial distress in the United States since the interest-rate-strengthening cycle initiated by the Federal Reserve. After the notable collapses of a few regional US banks, we’ve seen credit tightening in the United States: lenders appear to be pulling back from new originations, and there’s strong competition among dealmakers for the credit that is available.

We don’t expect to see the same level of capital pressure in the Canadian banking system. But we have seen deal flow in Canada in the first half of 2023 impacted by credit tightening. In the Canadian case, this is largely because of expectations around the impact of inflation on borrowers and banks’ concerns around potential credit losses.

So what will this mean for Canadian dealmakers?

Buyers will need to be prepared to not just rely on traditional funding sources (albeit with lower leverage), but to also be very purposeful about securing available capital and a funding structure before committing to a transaction. They’ll also need to make sure they’re using all the tools available to them. This includes vendor takebacks, earnout structures and government programs.

Sellers, on the other hand, will need to be armed with data and hyper-prepared for a granular due-diligence process. It will be to their benefit to de-risk the transaction as much as possible for the buyer and their funding sources.

When we look at ways to create value that have been successful in difficult market conditions in the past, divestitures are top of mind. Many forward-thinking companies are already engaging in strategic reviews to identify which parts of the business they should divest to optimize, as well as to stay ahead of shareholder activism.

A recent PwC US survey found 57% of companies that tried to fix a business unit rather than divesting said the unit’s performance deteriorated or stayed the same.

While the decision to divest will in many cases take imagination and even courage, there are three critical actions leaders can take to position their organizations for a stronger future. The first of these is to make timely decisions, understanding that speed often improves returns. The second is to infuse divestitures into your corporate DNA, meaning in practice that your organization considers divestitures multiple times a year. And the third is to understand and overcome organizational forces of inertia around divestitures and decision making more broadly.²

The goal is to be in a position to continuously evaluate your organization’s core capabilities and the market, and then shed assets that aren’t core to focus on what is in a disciplined way. This will free up cash to reinvest in higher-growth areas, and the to-be-divested assets will provide valuable buying opportunities for others.

With the removal of government stimuli from the market and high interest rates, restructurings and insolvencies are both up. This marks a return to a historical norm that’s been absent from the market for years.

It’s important to understand the extent to which there will be opportunities for organizations to use acquisitions and distressed M&A to differentiate themselves and leapfrog over competitors. While companies might be underperforming, many will come with valuable assets, for example, intellectual property, that could be extremely valuable to acquirers.

The uncertainty that surrounds events that lead companies into distressed and special situations often makes those situations extraordinarily difficult to evaluate.

To successfully take advantage of a distressed opportunity, organizations will need to be ready to mobilize, swiftly identifying the right target, evaluating the opportunity, executing the deal and mitigating risk.³ To optimize the synergies and transformative elements of a distressed deal, especially within the current economic conditions, both the organization and its tech and intellectual property environment need to be prepared to absorb acquisitions quickly and effectively.