Deal Dynamics in a COVID-19 World

In an uncertain market, cash is king. And the private equity world is sitting on record levels of cash, waiting to put it to work. According to a recent report, $830 billion of buyout-related dry powder was sitting with private equity funds at the end of last year, and more than half of it sits in North America. Disruption caused by the coronavirus pandemic will certainly slow the usage of these funds, but the changing dynamics will likely create exceptional buying opportunities for prudent investors.

Tightened Lending

Lending has tightened and continues to do so as banks and other lenders are waiting to understand the full impact of the pandemic on the broader economy. Between the pandemic and various government stimulus programs, there are still many unknowns. Lenders will continue to issue loans, but until there is more clarity, asset-heavy businesses might be the only deals that get done. Dealmakers will likely have to put more equity into the transactions and get creative with their deal structures, using mechanisms such as seller notes to circumvent conventional lenders.

New Opportunities

One of the primary motives for a founder to sell his or her business is to de-risk their personal portfolio, taking some “chips off the table.” With the sudden and unforeseen downturn caused by COVID-19, the logic behind this thought process has never been more sound. As many small businesses struggle to stay afloat, those that survive will no doubt emerge different than before. These businesses will likely be more open to potential partners or exit opportunities, which opens the door for private equity firms.

A Buyers’ Market

With a potential influx of sellers in the market, the dynamics will likely shift the pendulum from a pre-pandemic sellers’ market to a more buyer-friendly market. Valuations will likely fall as the pendulum shifts. Once sellers accept the depressed valuations in the market, deal activity will likely accelerate. With an increase in potential buying opportunities, sellers will have to differentiate themselves from the pack. Sellers can stand out through preparation and a fundamental understanding of both financial and operational changes to their business.

Concentrated Due Diligence

Both buyers and sellers will face increased scrutiny throughout the acquisition process. Most parties will understand a downturn in business caused by the pandemic. However, buyers and lenders will want to understand the long-term impacts to the sellers’ customer and supplier bases to ensure the company’s ability to achieve earnings consistent with what is presented in the contemplated transaction. Additionally, many employers have trimmed their workforce or furloughed certain employees. Understanding efficiencies that could be garnered post-pandemic, run-rate compensation, outstanding severance, or other payroll-related liabilities will be important in navigating due diligence and getting the deal to close.

Many businesses have received cash flow assistance throughout this pandemic. Whether the business received cash through the CARES Act, the Centers for Medicare and Medicaid Services’ Accelerated and Advance Payment Program, or other legislation, parties will need to understand how the funds were used and the impact to the business’s ongoing cash flows. For example, will the Paycheck Protection Program loan be fully forgiven or only partially forgiven? Was the loan used for approved expenses? How should these loan proceeds be handled as part of a transaction?

We’re Here to Help

With the additional risk buyers, sellers, and lenders face in this market, a trusted partner is more important than ever. If you are considering acquiring or divesting a company, our dedicated transaction professionals are here to help. Please reach out to your KSM advisor or complete this form.

Visit the KSM COVID-19 Resource Center