Long-lasting inflation is always a top concern because it decreases the value of currency and weakens the purchasing power of the American dollar. Since 2021, inflationary rates in the United States have increased at a much faster rate than predicted and central banks across the globe are reacting by raising interest rates.[1] Simultaneously, supply chain risks and production prices are increasing.[2] It may be obvious, but these consequences of influence M&A deals and the valuations of target companies. If you are debating on whether to initiate a sale, merger, acquisition, or other similar transaction, or if you have already decided to move forward and are currently in the midst of negotiating a deal, it’s important to understand the various effects that inflation has on M&A deals.
Common Effects on M&A Deals
As inflation continues to rise, buyers and sellers should expect to see more heavily negotiated purchase prices, alternative payment methods, and longer exclusivity periods.[3]
- Lower Purchase Prices: The cost of operating a business will increase with inflation and, if buyers cannot mitigate the impact of these costs, then they may begin to offer lower purchase prices.[4] This was evident in February 2022, when the M&A deal value declined by 74.4%.[5] Buyers may be aware of this trend and use it as a negotiation tactic. Sellers should work closely with their attorneys to discuss these tactics and factor in a purchase price buffer to account for such negotiations.
- Alternative Payment Methods: Inflation also increases the costs of interest rates, causing buyers to propose alternative payment structures. In times of inflation, a buyer is less willing to pay cash at the time of closing. In these situations, sellers should work closely with their attorneys to negotiate alternative payment methods such as installment payments, promissory notes, earnout/revenue milestone payouts, rollover equity and/or payment via other equitable assets.[6] In many cases, sellers’ attorneys will condition the deal on buyer’s ability to obtain satisfactory financing.[7]
- Exclusivity Periods: Buyers always want to understand the company’s pricing arrangements with its suppliers and the contracting parties’ ability to amend the terms of the agreement; however, this becomes even more critical during times of inflation. Therefore, sellers may start to notice buyers requesting longer exclusivity periods to give the buyers time to perform a more detailed due diligence review.[8]
How to Avoid the Negative Side Effects of Inflation
Inflation may deter buyers from offering higher purchase prices because they may worry that the ultimate payout won’t be as good as it would be in a non-inflationary scenario. However, in many cases, sellers can work with their accounting and legal advisors to demonstrate that their rate of profit growth will outpace the rate of inflation.[9] Sellers may choose to provide that data in terms of units sold and/or the dollar value. [10]
Ultimately, inflation matters in deals, especially when inflation rates are high and the duration of the inflationary period is long term. Inflation may be a concern when it comes to deal discussions; however, it should not derail the sale process. Buyers and sellers should work closely with attorneys to understand the potential implications of inflation on their M&A deals and to make sure they are negotiating the proper purchase price.
Thank you to Kimberly Lee for her research and writing assistance on this article.
[1] Tom Manion, Principal, Valuation & Capital Market Analysis, BDO (May 2022), https://www.bdo.com/insights/industries/technology/how-interest-rates,-inflation,-and-geopolitical-un
[2] Id.
[3] Ana Calves, The Potential Impact of Inflation on M&A, Mergers & Acquisitions (June 7, 2022), https://www.themiddlemarket.com/opinion/the-potential-impact-of-inflation-on-ma
[4] Calves, supra note 3.
[5] Brian Scheid, Peter Brennan, & Annie Sabater, Inflation Puts Dent in M&A After White-Hot 2021, SPA Global (Apr. 4, 2022) https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/inflation-puts-dent-in-m-a-after-white-hot-2021-69551549.
[6] Calves, supra note 3.
[7] Id.
[8] Id.
[9] Michael Collins, How Does Inflation Affect an M&A Deal, ProSales (Apr. 5, 2021) https://www.prosalesmagazine.com/business/how-does-inflation-affect-an-m-a-deal_o
[10] Id.