Back in April, I was delighted to learn that our team at Generational Group had closed our 900th transaction in company history. At any time this would be considered a fantastic milestone to pass, and I am of course incredibly grateful to the continued hard work of our associates and the wonderful support of our clients.
For us, every one of these 900 (and counting) transactions represents a business owner that we have helped secure their financial legacy, so that they can reap the rewards of their investment into their company and enjoy life beyond business.
Yet, considering the life-altering circumstances of the last few months, this achievement has a whole different meaning to me. It demonstrated that, even in these times of hardship, where families, communities and businesses have been changed forever, the resilience and commitment of entrepreneurs continues to hold firm.
Of course, the COVID-19 pandemic has changed deal making at least temporarily, which I will explore in this article. But, it is the perseverance of the entrepreneurial spirit, particularly within the middle market, that gives me a great deal of confidence for life beyond this crisis.
Optimism for the Future of Middle Market M&A
In my previous article, I highlighted several reasons why I remain confident in the foundations of our economy and the bullishness of buyers in the face of this unprecedented challenge. And I’m happy to report that a couple of months later, nothing has dampened this feeling. If anything, it’s grown even stronger!
The robustness of our banking system continues to be a source of comfort in these hard times for individuals, families and businesses, with central banks offering reassurance that they will be introducing measures to stimulate economic growth and protect incomes.
But beyond that, I’m encouraged by the attitudes of middle market entrepreneurs and their prospects for M&A activity after this pandemic. A survey of SME owners conducted by Permanent Equity recently revealed some reassuring statistics, including:
- 32% of owners surveyed said their companies’ revenue had remained stable or even expanded during the pandemic
- 40% expect their revenue will be back to 2019 levels within 6 months of life returning to some form of normality
- 76% believe their business will emerge from the COVID-19 crisis stronger than before
These are great signs for the resilience of the middle market, and indicates that these companies are not statically waiting for this all to blow over – they’re adapting to the “new normal” with changes like remote working and investments in technology, which will then benefit them once we have overcome this challenge.
That’s an attitude we’ve also taken at Generational, changing our practices to protect the health and wellbeing of our associates across the country while continuing to meet the needs of our clients in these unique circumstances.
Because, particularly in the lower middle market, transactions are still moving forward. While the press will often focus on the decline in billion-dollar deals due to the uncertainty COVID-19 has caused, the timeline to deliver ROI for smaller deals is significantly longer, meaning there’s less risk associated.
But how has deal making changed in the face of this new landscape? How could this affect a business owner’s approach to planning their exit?
Exit Planning in the COVID-19 Era
When discussing how COVID-19 has adjusted the deal making process, I think it’s vital to start with how we should determine a company’s value.
Regular readers of Generational Equity’s insights will likely be familiar with recasting. That is when a professional M&A firm will examine your financials to account for any one-time expenses that would not impact on its new owners. These can include:
- Losses due to fire
- Losses due to employee embezzlement
- Other business disruptions beyond your control (floods, earthquakes, tsunamis)
- Any of your compensation that was above fair market value
- Travel and vacations for you and your family that the company expensed
This is a widely-accepted process and helps provide a more accurate picture of your company’s worth for a prospective owner. However, moving forward there will be another important element to include on this list: the loss of revenue or income as a result of COVID-19.
As Northern Trust reiterates in a recent article:
Moving forward, we expect the due diligence process to include questions that help buyers better understand the specific impact of COVID-19 on the business, and its general level of preparedness for a global pandemic.
By accounting for this unprecedented disruption when recasting your company, you can offset any concerns or doubts of buyers, and also increase the likelihood that you will maximize the value of your business sale.
Furthermore, if you are able to adapt your financial forecasts to demonstrate why your business won’t be greatly impacted by COVID-19, this can give you a significant competitive edge among potential buyers. Remember, private equity firms are still sitting on upwards of $2 trillion in dry powder – this still needs to be invested, and means a well-prepared company can still secure a premium on their business.
This recognition of COVID-19’s impact on business operations has led to the expansion of EBITDA to EBITDAC:
- Earnings
- Before
- Interest
- Taxes
- Depreciation
- Amortization
- Coronavirus
No, this isn’t a bad joke – it is a reflection of the sizable effect that COVID-19 has left on many businesses across numerous industries.
As well as the transformation COVID-19 has had on determining business valuations, it’s important to consider how deals will be structured. We’ve spoken at length in the past about earn-outs and their prevalence in deal making, but in this new environment, they are likely to become even more sought-after.
Again, Northern Trust emphasizes this point, saying:
We also expect to see buyers paying a greater portion of the purchase price in the form of an “earn-out.” We believe sellers who adjust their mindset, show a willingness to be more flexible on deal terms, and who recognize that the transaction process is going to take longer in this new environment are likely to be at a competitive advantage.
This reinforces the need to be supported during your exit planning by a professional M&A firm, because this will help prevent any earn-out from being too heavily weighted in favor of the buyer: the deal structure also needs to benefit you (the seller).
The advice of an experienced M&A advisor will also give you a clearer picture of what deal structures are more beneficial than others. This could allow you to establish an earn-out structure that is actually more financially advantageous in the long-term than a more cut-and-dry transaction
Fundamentally, we are in challenging times when it comes to deal making and exit planning. Information seems to change every hour, and it is important that, as a seller, you are working with a true professional that has experience in closing deals no matter what the economic cycle and understands how to secure an optimal deal structure.
Maintaining Your Journey to Exit
I hope this has given you a greater understanding of how M&A activity is continuing to take place, and how deal making is evolving in order to meet the challenge.
Even in these difficult circumstances, dealmakers across the U.S. are striving to help push deals over the line, including our diligent associates at Generational, and I believe this should reassure business owners about their prospects of exiting both now and when COVID-19 has passed us by.
Above all else, I hope you take away from this the value of being supported through your exit plans by an experienced firm that has managed clients through all kinds of economic cycles. In trying times such as these, it is that experience and expertise that will keep your exit plans on track and keep you on course to an effective, satisfying exit.
If you want to keep up with the latest trends and news related to the economy and its impact on your approach to exit planning, I’d recommend subscribing to Generational’s regularly updated insights.
Until next time, I’d like to wish you, your family and your business nothing but the best as we continue to manage and overcome this challenge.
