How COVID-19 Is Changing the Face of Manufacturing M&A

While COVID-19 continues to ravage all sectors of the economy, some industries have been harder hit than others, maybe none more so than manufacturing. But there is a silver lining to this dark economic cloud, and it comes in the form of deal dynamics.

The private equity world is currently sitting on record levels of cash. According to a recent report, $830 billion of buyout-related dry powder was sitting with private equity funds at the end of 2019, and more than half of those funds are in North America. Disruption caused by the COVID-19 pandemic has and certainly will continue to 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 manufacturers 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 and earn outs to circumvent conventional lenders.

New Opportunities

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

A Buyers’ Market

With a potential influx of sellers to 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 as the new normal 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 manufacturers 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 manufacturers have received cash flow assistance throughout this pandemic. Whether the business received cash through the CARES Act 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 professionals are here to help. Please reach out to your KSM advisor or complete this form.

Visit the KSM COVID-19 Resource Center