M&A Expectations After The Covid-19 Pandemic

It’s no surprise that the COVID-19 pandemic slowed M&A deal activity overall in 2020. According to data from PitchBook, more than 2,000 transactions closed for a value of $336.8 billion in Q2 of last year. That represents a 41 percent decline in the number of deals from Q1. Yet, deals did pick up in the second half of the year, which is likely to continue, as businesses are poised for improved economic conditions that leave COVID-19 in the rearview mirror.

Deals that were in negotiations prior to COVID-19 faced three different fates once the pandemic set in. Either one or both parties walked away from the table because of the economic uncertainty. The buyer and seller found a way to renegotiate after considering the impacts of the pandemic. Or the parties moved forward because the business at hand continued to perform with limited impact from COVID-19.

Some buyers and sellers have adjusted to the new landscape, still finding ways to get deals done, largely dependent on the circumstances of the sector the companies operate within. For example, buy-and-build strategic transactions have been ongoing for private equity add-ons and acquisitions by financially healthy corporations. Pitchbook data shows that add-on acquisitions accounted for more than 70 percent of all PE deals in Q2 of 2020. Additionally, big corporate buyers with strong balance sheets continued to acquire companies that further their business strategies. Now that vaccine availability is increasing, we can expect nearly all things economic to trend back to normal, pre-pandemic levels, and deal activity should certainly pick up.

On the sell side, much activity has stemmed from family-owned businesses that have done well during the pandemic because they were either an essential service or product, or somehow otherwise immune to the impacts of the pandemic. In any case, there have been fewer quality assets on the market. This means that quality businesses coming to market continue to be in high demand.

In the post-COVID environment, price adjustments could be more contentious than usual, even in cases of the most meticulous due diligence. Deals are being subjected to added scrutiny, affecting purchase price adjustments and how much the buyer owes, and how much the seller gets. Under these circumstances, there are certain factors that are getting more attention when it comes to getting deals done:

• In the U.S., it should be considered whether the target company received any loans from the Paycheck Protection Program (PPP) or funds from stimulus packages such as the CARES Act because they artificially impact the balance sheet. It is also important to know if the loan will be forgiven, or who is responsible for paying it back.
• The closing date of a deal is significant because the value of working capital adjustments, such as uncollectable receivables or inventory, can vary greatly depending on timing.
• Earn-outs have also been impacted by the pandemic. Many sellers are in a poor position if earn-out targets are no longer attainable. Purchase agreements that include requirements for the buyer to run the business consistent with past practices during the earn-out period can lead to disputes, and buyers must show that their actions were in response to the effects of the pandemic. Parties can reduce the risk of these disputes by closely considering historical data and future performance when determining target working capital, including a collar limiting the purchase price adjustment to certain thresholds, as well as specific parameters for accounting practices used to measure COVID-19 impacts.

Needless to say, M&A deals can be more contentious thanks to the precarious nature of spending an entire year of life weathering a global pandemic. But not all sectors are being affected in the same ways.

Many industrial companies were forced to halt operations during the pandemic, causing massive interruptions of manufacturing and supply chains. This resulted in certain inventory shortages. Reopening required time and money to get back on track under new procedures for social distancing, sanitation procedures, and providing necessary personal protective equipment. While some manufacturers have struggled, some in select categories, such as hand sanitizing products, have seen a surge in demand and growth, albeit temporarily. The fleeting nature of businesses being affected in such a way because of pandemic-driven demands presents added uncertainties for buyers eyeing these types of companies.

The more discretionary of the healthcare services, such as dental care and elective procedures, saw an immediate decline in the early stages of the pandemic. But these businesses have mostly bounced back as safe ways to operate became more acceptable.

COVID-19 has also shaken up the business services sector. Businesses that specialize in video conferencing or security software have enjoyed significant sales increases. Cleaning services have also been in great demand. All things e-commerce are up. Transportation services related to grocery delivery are doing well. Professional consulting services have slowed, but most firms are maintaining staff levels in anticipation of a return to normal.

Data indicates that the sectors that exercised deal-making restraint during the pandemic will be behind the next wave of M&A activity. Take the consumer sector, for example. It saw an M&A boost involving assets that were facing difficult times, led by more financially healthy competition. Also more popular are buyouts from innovative companies with strong customer bases.

Private equity firms are well positioned to be even more active this year and beyond, as businesses reposition themselves for recovery and PE sits on a ton of dry powder. Also, the growth of special purpose acquisition companies (SPACS) may continue to bring other forms of capital to the market. Alternative deal models are also expected to drive deal making in the near future, such as joint ventures and divestments for strategic business shifts, as some companies will look for ways to combine to capitalize on the recovery in a world where consumer behaviors have been transformed over the past year.

As vaccines become more widely available and as businesses begin to recover from the pandemic, M&A activity is expected to stay on the increase. Simply consider the backlog of deals that were put on hold due to the events of the last year. Buyers are ready to pounce, interest rates are low, stock markets are high, and GDP is poised for growth. The M&A outlook for 2021 is bright. Planning and due diligence will be key for companies that have weathered the storm that was 2020. And Benchmark International is here to make sure your business is ready to take advantage of all the different opportunities that the next year holds.