Market Responses to COVID-19

While the pandemic of COVID-19 has reshaped the economy, stock markets, and, notably, personal behaviors, it has also had a significant impact on the M&A market and transactions. Certain deals are less impacted by the pandemic because of the stability of certain end-markets or strategic rationale outweighing short-term uncertainty but select other deals have been put on hold or terminated altogether. Whereas we’ve seen strategic buyers (those in the same industry as the target company) generally continue their pursuit of transactions, we’ve seen private equity buyers take greater “pause” during this time to digest the challenges with deals in the time of COVID-19, including:

Valuation Uncertainty. Traditionally, valuation is a factor of market conditions, leverage and company performance, all of which are realizing material uncertainties as a result of COVID-19. While some deal values are negatively impacted as a result of the lack of clarity over the next six months to a year, others are holding value while utilizing non-cash consideration (contingent earn outs and/or seller notes) to bridge any gaps in capital structure. Of course, there are other deals that are either put on hold until we achieve some stabilization in the pandemic and economy or moving forward as-is with no changes to deal terms as a result of COVID-19. 

Debt availability. While debt is common among most transactions, private equity has applied its use of leverage to boost rates of return while minimizing the equity contributed to deals. Currently though, banks are focused on satisfying Paycheck Protection Program (PPP) loans versus acquisition financing. Additionally, they’ve generally mitigated risk by reducing the leverage metrics, which then requires more equity in the deal and reduces the internal rate of return…leading to lower valuations even with strong company performance through COVID-19.

Due Diligence Challenges with Social Distancing and “Safer at Home” Mandate. While most of an M&A deal can be conducted remotely, there are still certain steps to the transaction and due diligence that must (or a strong preference to) be conducted in person. Anything from seeing the operations to meeting the seller and management group, real estate review and surveys, environmental assessments, financial diligence and questions, and many others, are most appropriately conducted in-person. While certain of these steps are easier than others to host remotely, it’s unlikely any buyer will complete a transaction without at least some travel and face-to-face meetings.

Timing to Close. The markets respond poorly to uncertainty and we have plenty of it. Even more challenging is that we don’t know whether the economy will quickly bounce back upon COVID-19 stabilization or if we go into a longer recession. Accordingly, it has become very difficult to predict the timing of a transaction given the impacts on deal terms and timing when we don’t know how long we’ll see reduced volumes and profits, supply chain interruptions, plant shutdowns and split-shift operations.

Competition with Strategic Buyers. Assuming the base business of a strategic buyer (which could be a corporate buyer or a portfolio company owned by private equity) is minimally impacted by COVID-19, it presumably has a competitive edge to make acquisitions relative to private equity buyers. First, corporations generally have a lower cost of capital. Second, with add-on acquisitions, corporations might have cash readily available without involving lenders in the transaction process. Third, strategic buyers would likely have strong industry awareness reducing the “lack of knowledge” private equity buyers generally need to fill through on-site visits and in-person meetings. Fourth, strategic buyers likely understand how COVID-19 is and will impact the target company as it’s also in that same situation. Lastly, and most importantly, strategic buyers might have an underlying long-term synergistic rationale for the capabilities, geography or customers of the target, which possibly outweigh the risks related to an acquisition in the time of a pandemic.

Recessionary Fears. After more than a decade of upward momentum and now a global pandemic, we’re now experiencing recessionary dynamics, and many believe that a longer-term downturn is inevitable. Economists were speaking of the inverted yield curve sending recessionary signals and now the economy is all but purposefully shut down.  Accordingly, certain buyers, which includes both corporate and private equity, are showing greater risk aversion and caution.

Minority Investing. As liquidity becomes more of a focus and capital structures are tested, private equity groups have rolled out minority structured equity options, which means it would generally be taking a non-control position in a target company to provide investment capital and liquidity, monetization of owners’ investment and resources for opportunistic growth through this unique time period. Possible structures of private equity investment could include long-term or no-amortization debt or preferred securities.

So, what does this mean for sellers or those considering a sale in the next 6-12 months?Be proactive…plan early and speak to an experienced investment banker regarding the current market, options and appropriate preparation. Taureau Group is proactively working with business owners to prepare for and build value prior to commencing marketing efforts at the right time, which could vary by business depending on volatility during this time and end-markets served. There is also likely to be a pent-up demand for businesses when the market stabilizes, so it’s important to be prepared and ready to go to market quickly upon such time.Understand your personal objectives (e.g. to mitigate risk, maximize value, destress during the uncertainty, grow, exit, etc.) along with your capital structure and reality of weathering the impacts on your business related to COVID-19. Based on the topics above, it could be logical to seek out a new financing partner to find those lenders that are more flexible during this time and/or seek a capital partner.Be realistic…understand that many transactions are realizing certain challenges currently and it’s up to both the buyer and seller to show the flexibility and responsibility to move the deal forward, which could include timing, virtual meetings and debt financing and structure changes.Categorize the financial impacts of COVID-19 on your business, such as impacted revenues, incremental costs related to split-shift production, pandemic-related benefits or otherwise.Position your business to achieve your objectives by understanding your short-term and long-term capital and liquidity needs based on various scenarios upon the COVID-19 impact. It’s important to not only understand your cash needs during a slowdown, but also for the time period when normal volumes return.

And, what does this mean for companies and private equity firms searching for acquisitions? Similar to sellers, buyers must understand the realities of M&A under the current COVID-19 pandemic and have the cash on hand or financing relationships to appropriately structure transactionsIt’s a good time to explore acquisitions…given the challenges some businesses are facing and the uncertainties around COVID-19 and a longer-term slowdown, Taureau Group has realized a higher number of acquisition targets are willing to consider a transaction.Develop a due diligence process that minimizes the requirement for in-person meetings and limits on-site diligence.Don’t waste time…if you can’t get comfortable with some uncertainty, the timing of looking at an acquisition could be challenging. Let’s face it, no one knows when the economy will open up upon stabilization of the pandemic or the lasting impact on the overall economy and market health.As stated above, certain private equity groups are adapting to the current times by supporting companies with non-control structured equity. Most buyers are going to have to show some flexibility to address the long-term requirements of sellers and get deals done.

In summary, COVID-19 has had a dramatic impact on the M&A market as it has to the entire world economy. While certain deals are put on hold or floundering, others are getting done because of the strategic nature of the deal or the proactive awareness of both buyers and sellers to develop flexible solutions to the realities of the market. 

At this time more than ever, it’s important to understand the complexities currently being faced so that you can proceed in the most efficient manner to accomplish your personal objectives, maximize value, and protect confidentiality. 

Taureau Group Overview

Taureau Group is an independent boutique investment bank providing merger and acquisition services to lower middle-market companies throughout the world. Principals of Taureau Group have successfully completed hundreds of M&A transactions for a wide array of clients in virtually every industry. Transactions typically involve closely-held and family-owned businesses, and private equity firms with transaction values ranging from $10 million to $150 million. Taureau Group combines the capabilities of large, bulge-bracket investment banks with the service and responsiveness of the middle-market.

Please contact any of our experienced M&A professionals here to discuss how COVID-19 may impact your M&A strategy.