How has the M&A environment been impacted by COVID-19? Our panel explores the current state of dealmaking and shares predictions for the M&A landscape as we close out the year and head into 2021.
Speakers:
- David R. Brown, NP Corporate Partner
- Sam Kim, NP Corporate Associate
- Dan Strzalka, NP Global Finance Partner
- John Chalus, Director, BMO Financial Group
- Brett Holcomb, Principal, Prospect Partners
- Jeff McNamara, Director, Industrials M&A, Duff & Phelps
Key takeaways from our conversation:
- The M&A environment in the U.S. has started to rebound. Albeit, not all industry sectors are rebounding at the same pace. Brick and mortar retail and restaurants are two sectors that were directly and immediately impacted by the pandemic and really continue to operate under a shadow of uncertainty. But on the opposite end of the spectrum, we've seen the technology sector, especially online retailing, telemedicine, and other areas, which are unaffected or even boosted by changes in consumer and business behavior, continue to perform well and attract capital. Overall, deal flow continues to recover, but it's industry- specific and more company-specific than ever, with a stark divide between the marketability of stronger and weaker businesses.
- Pressure to deploy capital. Companies within the S&P 500 are sitting on approximately $3 trillion in cash. Combine that with private equity firms that have accumulated over $1 trillion of dry powder, and there's certainly a lot of pressure to deploy capital. What's particularly unique and interesting with the economic cycle we're experiencing right now is that the economy was quite strong before the COVID-19 pandemic hit. From an M&A perspective, the market was fairly robust, driven by persistently low-interest rates and record amounts of dry powder that continued to fuel transaction activity. For large corporations, M&A has served and continues to serve as a key area of strategic focus to help drive growth, particularly as companies sit on elevated levels of cash and seek to innovate by acquiring disruptive technologies they could not develop in-house. It existed before the pandemic and remains so today.
- Social distancing and travel restrictions have thrown a curveball to the dealmaking environment. Generally speaking, the go-to-market process and the steps involved are fairly similar in a post-lockdown environment. There's a level of flexibility needed in the sale process, and the overall timeline may need to get extended as buyers conduct their diligence on a remote basis. But at the same time, we've seen efficiencies that have been gained, as certain in-person meetings that once required travel have shifted to videoconferences.
- We've seen a shift in deal structures. To help bridge the divide on valuation, we've seen earnout structures take on even more importance, which helps bridge the gap between seller optimism and the inherent level of caution that buyers have, not knowing what the next 12+ months have in store. There are plenty of tools you can use to structure deals, but parties must show increased flexibility as to both process and structure.
- 13-week cash flow forecasting. Another tool we've seen utilized during the pandemic is the use of 13-week cash flow forecasting. It can provide a valuable viewpoint into the business, including the way it functions and converts sales into cash, and enables buyers to make very granular decisions that ultimately become very strategic. Previously, we saw this tool used more frequently in distressed company deals, but its value for healthy companies has increased dramatically in this environment.
- Cash is still king. From a private equity perspective, the early innings were spent triaging the portfolio, moving to "red, yellow, green" and getting management teams on the same page as to the severity of the crisis. From there, once on the same page, the focus shifted to cash flow and liquidity—cash is always king, especially in these situations.
- One size does not fit all for exit strategies. As a whole, the pandemic environment has pushed some exits back, but that's not necessarily a universal statement. The bigger the COVID-19 impact on the business, likely the longer the exit timeline will be pushed out. If a seller can prove that it can withstand, and thrive during, the pandemic, it should be going to market sooner rather than later. If the business has held to its expected course, on par with last year but down from budget, the pandemic probably hasn't impacted its exit outlook. However, for weaker businesses or sectors that are really suffering, such as the restaurant or brick and mortar retail sectors, you're looking for really delayed exits.
- Prepping for a sale. "Getting your financial house in order" has only become more important during COVID-19. Perform sell-side diligence and address any risks that may be an issue in a potential sale. Consider strengthening your force majeure and early termination provisions to address pandemics. Particularly for weaker businesses, there is an opportunity here to right the ship for a post-COVID-19 exit.
- Different approaches to handling Paycheck Protection Program (PPP) loans. We've seen companies pay it off to eliminate it as a problem in the deal structure. Others choose to treat PPP loans as non-debt items, given the "certainty" they will be forgiven. Very commonly, there's a negotiation process, escrow coverage to protect the parties if the PPP loan forgiveness ultimately looks different than presently expected. This, of course, depends on the relative size of the loan to that of the deal. In a large deal with a fairly small PPP loan, more creative approaches might not be worth pursuing. We've seen the emergence of insurance products that resemble representation and warranty insurance.
- PPP forgiveness? We don't expect to get clarity on any PPP loan forgiveness this calendar year; we're looking into potentially February of 2021 until we get any meaningful clarity on forgiveness.