e-Commerce: 6 M&A Success Factors for Online Retailers
Companies in the e-commerce space considering an M&A transaction should look at these areas for valuation adjustments, which offer benefits both on the sell-side and buy-side.
While mergers and acquisitions (M&A) activity in 2020 started off turbulent and unpredictable, the second half of the year saw a resurgence of deal-making that shows no signs of slowing down in 2021. However, not all industries experienced a commensurate impact.
One of the segments that has immensely benefitted from the impact of COVID-19 and continues to ride the upward wave is e-commerce. Pandemic-related stay-at-home orders and remote work accelerated consumer behavior trends and preferences toward online shopping, while technology emerged to support and further this evolution. M&A activity in the e-commerce segment has also seen gains as near and mid-term performance and valuations for businesses in this industry exceed forecasts for the majority of other industries.
Kaufman Rossin’s transaction advisory and M&A due diligence team has assisted numerous clients in the e-commerce space, including B2C and B2B retail, manufacturing and distribution companies, and/or their acquirors. The following are six of the most impactful valuation adjustments we have seen our clients benefit from in this new climate.
1. Allowance for RMA
It is understandable that not every high-growth company has the resources or the experience to properly accrue for RMA (Return Merchandise Allowances). Sometimes those allowance rates are determined by their ultimate customer terms (e.g., 30-day window for Amazon versus 90-day to lifetime for Costco), and sometimes the necessary and reasonable allowances could be affected on a client-by-client basis depending on evolving product mix and historical trends. Needless to say, this is an area worth evaluating thoroughly prior to the company going to market. Failure to do so could result in inconsistent and incomplete financials and significant delays in the deal timeline.
Experienced e-commerce investors are highly aware of the importance of allowances and the nuances in corresponding accruals that vary based on online platform return terms, specific large retailer requirements, trends in one-time audit chargebacks, and related areas. There is almost never a one-rate-fits-all solution, which also opens the door for negotiation in select cases.
2. Pro-forma for logistics, freight or lease changes
As companies continue to optimize and scale their logistics during the pandemic, their efforts often can result in certain accretive or dilutive effects on their bottom line. Additionally, extraordinary freight charges resulting from the tightened freight capacity during the past few months may have had a so-called “one-time” extra expense impact. These changes have presented an opportunity for e-commerce businesses to pro-forma adjust or normalize the company’s performance based on more leveled assumptions.
Conversely, for a buyer the above changes may have presented deductions or add-backs to the valuation of their target. Notably, we have observed more acquirors of e-commerce companies being willing to consider select one-time adjustments resulting from the pandemic as more investors have flocked to this very desirable, high-growth industry.
3. Not capitalized R&D
Across the board we see companies who are not taking advantage of assessing research and development (R&D) and other investments, which may qualify for capitalization or one-time considerations – in addition to significant tax savings through the R&D tax credit. For example, they may have invested in software development to build an API that connects to their clients or invested in the development of robotic process automation “bots” to streamline processes. A proper analysis of any R&D spend is often worthwhile as it can yield a higher valuation for a seller.
On the buy-side, acquirors have in some cases benefitted from lower target valuations resulting from fully loaded R&D expenses. Conversely, some buyers have also evaluated and identified potential risks should their target not have invested sufficiently in technology to scale their business. In many cases, that is an opportunity to pro-forma the target’s performance and normalized free cash flow forecasts.
4. Sales tax diligence
To date this is by far one of the most overlooked areas we have seen with clients, who often leave it at the bottom of their priority list given they have a business to run and growth and operations to manage. However, this is an area you need to pay attention to.
Sales tax exposure can arise from many transactions (asset sales as well as stock sales). One example of particular relevance to e-commerce businesses is potential sales tax liability related to the South Dakota v. Wayfair, Inc. Supreme Court ruling in June 2018. This ruling shifted the tax collection and reporting burden for online purchases from consumers to businesses, and it broadened a state’s ability to impose a sales tax collection requirement on out of state sellers. Since then, states have established different sales volume thresholds, which determine a business’ tax liability.
Sales tax more often than not is an issue that arises in M&A deals. We highly recommend a comprehensive sales tax evaluation as part of due diligence to avoid transaction hiccups, additional escrow requirements and/or eroding negotiation leverage.
Informed buyers are well aware of this common pitfall which can cost them substantially in retroactive taxes owed and have become very keen on sales tax audits or diligence assessments as part of the traditional due diligence process. That typically involves evaluating potential nexus in any state that the target may transact in and quantifying respective tax impact based on the type of customer and product.
5. Duties and tariffs
The duties and tariffs that the U.S. imposed on goods coming from China have resulted in additional costs for many businesses sourcing their products from the manufacturing behemoth. As some of the sanctions reversed over time, or companies relocated their supply chain to alternative countries such as Vietnam, etc., companies had an opportunity to adjust and normalize the previously observed impact.
Depending on their scale and ability to improve the target’s supply chain, select buyers are able to benefit from an acquisition with sub-optimal sourcing by incorporating them into an already optimized chain with lower pro-forma costs. In most cases with our clients, we have noted that these synergies are not shared with the target.
6. Launch of new channels/products
Successful launches of products and channels often require additional investments in marketing, advertising and other promotional activities. Many companies do not adjust for these extra “one-time” expenses and the resulting enhanced pro-forma profit.
On the flip side, we have assisted buyers who have benefitted from the lack of pro-forma adjustments in their target’s performance and growth. That highlights the fact that many sellers in the online retail space continue to leave money on the table when not sufficiently prepared for their exit.
The e-commerce sector is growing and evolving so rapidly that it continually presents new opportunities and considerations for insightful valuation adjustments based on the type of product, supply chain and ultimate end consumer.
While the above-mentioned areas are six of the most notable adjustments, Kaufman Rossin’s M&A transaction advisory team works to bring tailored, insightful value-adds to each of our clients. Additionally, our team collaborates with other firm professionals who specialize in providing tax, assurance and other services to businesses in the retail as well as manufacturing, and distribution sectors to bring a cross-disciplinary approach to our clients.
Contact me or another member of Kaufman Rossin’s transaction advisory team to learn more about how proper due diligence, including the factors above, can help your e-commerce business plan for a successful merger or acquisition, whether you are on the sell-side or the buy-side.
Nikoleta Angelova is a Business Consulting Services Director of Transaction Advisory at Kaufman Rossin, one of the Top 100 CPA and advisory firms in the U.S.