DEALMAKERS: Cautious optimism and flexibility prevail for deals in a COVID-19 marketplace

When COVID-19 first began to emerge as what would ultimately become one of the world’s costliest pandemics, it hit us when the U.S. economy was thriving. Unemployment was low. Jobs were plentiful. Transactional activity, including deals being completed within a robust M&A market, was accelerating. But in a few short months, the coronavirus changed everything. Suddenly, buyers and sellers were putting their hands in the air and asking, “How are we going to get our deals done?”

But deals did get done, and those that were far along pre-COVID-19 have closed. The dry powder from private equity and other investment firms was not going to be a limiting factor for the availability of equity. In fact, many well-established funds opportunistically raised billions of dollars in distressed funds, increasing the overall pool. Concern that frozen debt markets would lead to little available debt, thereby leveraging multiples and pricing, became a topic of endless discussion. 

But one thing we knew for certain was that we were all in this together. So, lenders stepped in, partnering with companies to extend loan periods, defer principal payments, and rewrite loan covenants. The federal government rolled out a toolbox of stimulus programs to shore up the economy and prevent a collapse that many feared would rival the Great Depression. Over a trillion dollars were set aside for businesses in our hardest-hit industries, and the American public received enhanced unemployment benefits and other financial support. 

As COVID-19 continued to wreak havoc on our lives, investors and their advisors grappled with the practicalities of getting deals done when in-person meetings became impossible due to health concerns. How can we conduct proper due diligence? How can buyers and their advisors understand critical deal factors such as the human element and cultural fit if they cannot look the management team in the eye face to face? Out of necessity, and like it or not, Zoom, Microsoft Teams, and other technology tools suddenly became the mainstay for how the deal-making community would conduct day-to-day business. 

Understanding how to assess the impact of COVID-19 on EBITDAC, working capital, normalized financial performance, and modeling the future 6, 12, and 24 months out was the subject of much debate. But creativity prevailed as investors introduced seller notes, earnouts, additional rollover equity, and other safeguards to address the risks. 

Today, as we continue to live with the pandemic in our daily lives, there is a new feeling of optimism among dealmakers. It’s beginning to feel like things are ramping up to pre-COVID-19 levels. As expected, there is no shortage of capital. Moreover, many business owners, having lived through the past several months of COVID-19 and fearful of what the election may bring, are now eager to do transactions. Professional service firms like CohnReznick that support M&A activity are now finding themselves dealing with resource allocation issues. Many have begun aggressively hiring.

If this all sounds extremely positive, it is. That is, except for the elephant in the room – Paycheck Protection Program (PPP) loans. Despite the program’s good intentions to provide a lifeline to lower middle market businesses, investors have quickly found that closing a transaction when a company is working through its PPP loan, or waiting for the SBA and others to finalize the forgiveness criteria, is almost impossible. Yes, there are creative solutions and workarounds, but they don’t mitigate the risks of doing a transaction. Companies that have been awarded PPP loans face new risks, such as sellers being blacklisted or loans that will not be forgiven. Some would argue that a business didn’t require the loan given they are able to enter into a transaction. Others would call this thinking short-sighted since the loan made it possible for the business to survive through the worst, thus remaining a viable target for an investor.

It remains to be seen how COVID-19 loan programs will impact the momentum we are seeing now in the market, as well as future deal activity in the months ahead. But one thing is for sure: The powers that created these programs need to step up and fix what needs to be fixed. Otherwise, all the good intentions and rationale for these programs could fall by the wayside.