The global pandemic has dramatically affected people, governments and businesses during the past year. Many companies have had to navigate a very dynamic and volatile environment, which has included employee and customer health concerns, rapid changes in product and service demand, and supply chain disruptions, among other items. Businesses that were contemplating M&A processes have had to carefully reassess the environment since the pandemic. Stout saw an initial pause in sell-side processes at the onset of COVID-19. However, launch activity has recently rebounded to pre-COVID levels and appears robust heading into 2021. We consider the following items among the most important in helping clients decide whether to move forward or delay launches:

1. The business and recent financial results have not been materially affected by pandemic issues. While there is no exact metric to use (e.g., percentage change in revenue or earnings before interest, taxes, depreciation, and amortization (EBITDA)), financial performance that has remained in-line with pre-pandemic performance or exhibited growth are good benchmarks. Figure 1 illustrates four general categories in which Stout defines businesses. The Healthy Market Leaders and Outperformers would best meet this standard though lower valuation standards or necessity could drive the other two categories
2. Run-rate financial results have trended back to pre-pandemic levels, demonstrated through several months of consistent recovery. Stout has found that three to six months of performance is typically enough to illustrate a trend
3. Backlog or project work portends substantial recovery in future months or provides greater visibility
4. Positive financing availability for the business or industry sector. A willingness of lenders to provide financing to the business or sector is paramount.

Figure 1. Middle Market Deal Quadrant

If one or more of the factors above are met, Stout has found an active M&A market. After witnessing a pause in activity during the late first quarter and the second quarter of 2020, financial investors/private equity (PE) and strategics resumed M&A activity. There is substantial capital available to the investors. Debt financing has also largely recovered from second-quarter levels, though certain industries have seen continued weakness (e.g., energy, retail, and travel and hospitality), and asset-based lending represented a meaningful portion of activity immediately after the first wave of the pandemic (versus cash flow-based lending).

The Marketing Stage

The initiation of transactions has encountered more modest changes (Figure 2). Stout has found most clients can accommodate limited in-person due diligence sessions prior to creating marketing materials, and fortunately, much of the due diligence process can be addressed remotely. The more creative element centers around how to position the business – how has COVID affected, benefited, altered the underlying business. Stout can also help companies manage other important planning that needs to occur prior to closing.

Figure 2. Middle Market Deal Quadrant Marketing Strategy

The marketing process itself has experienced relatively little change as this is typically managed via phone and email. Stout has observed minimal changes to firm responsiveness during the pandemic. One of the more challenging M&A process steps has centered around management presentations and site visits, subsequent to receiving initial indications of interest. A number of PE groups and strategics have restricted employee travel unless absolutely necessary. In order to address these buyers’ health concerns and move forward, Stout has adopted a hybrid approach to enable the important introductions and discussions between buyers to sellers. This approach has included:

1. Conducting socially distanced (and masked) management presentations to small groups of buyer representatives willing to travel to meetings
2. Conducting virtual Zoom management presentations for larger groups unable to travel
3. Offering site visits both in-person (in very small groups) or virtually through pre-recorded videos of plants and facilities
4. Data rooms – little to no change as these are universally done via online software

Getting to Closing

Another area in which Stout has witnessed more change is between signing a letter of intent and closing. Because travel has been restricted for many buyers and service providers, time to closing has typically increased in most transactions, but some deals are still closing on a “pre-COVID” timeline. Every Stout transaction that has closed during the pandemic has had at least one face-to-face meeting between buyers and sellers. In addition, most have required environmental surveys and site visits prior to closing. The logistics for these visits has required more robust advance planning.

Purchase Agreement Nuances

COVID-19 has also made buyers focus on certain areas of due diligence and created new conditions to closing. While buyers have consistently emphasized safety, they are evaluating workplace safety and health procedures more thoroughly. There has been renewed evaluation of employee interactions, given the potential for rapid spread among work groups and even company/customer interactions. In addition, Paycheck Protection Program (PPP) loans have become a key item of negotiation between buyers and sellers. Even if the loans are expected to be completely forgiven, a change of control may accelerate the loan and require it to be repaid at closing or that funds be escrowed in the remote chance it is not forgiven. In summary, several of the major changes in purchase agreement negotiations during COVID-19 have included:

1. PPP Loans
   1. Seller(s) may have to represent that the company was eligible for the PPP loan and that the proceeds were used in accordance with program’s guidelines
   2. Requirement that PPP loans be repaid prior to or at closing or have funds escrowed in the loan amount. If the loan is forgiven, escrowed funds would flow to the seller(s)
2. Material Adverse Change (MAC) and Other “Outs”
   1. Sellers have added a MAC exclusion for COVID-19 issues
   2. Buyers have added financing outs if “solely” related to impact of COVID-19
3. Health-related Conditions
   1. Certain purchase agreements may include a condition that no more than a certain number of employees are sick with COVID-19 at closing. A number of jurisdictions are requiring companies with a threshold level of infections to close for a period of time. Buyers want to ensure that they do not close on transaction where the target is effectively closed for several weeks.

Navigating M&A processes during a pandemic has created new challenges and issues to consider, but Stout has continued to achieve successful outcomes for clients. Proper planning and execution are paramount to this success.