Financial Management and Disaster Relief
Tips for Private Equity Investments During COVID-19
- Due to COVID-19, deals have been — and will continue to be — impacted for an undetermined amount of time.
- Prepare for a heightened due diligence process if you have an upcoming or in-progress deal.
- For both buyers and sellers, consider your specific industry and how you might mitigate risk areas.
- Plan for delays in deal closings and the launch of new sale processes, which may also affect the timing and completion of due diligence.
Dealmakers started the year with great hope. January and February saw 37% year-over-year growth, which was followed by a strong start to March as well. But as the year progressed, so did COVID-19. Recent discussions with professionals across various fields and industries have yielded differing opinions on COVID-19’s potential impact on upcoming deal activity.
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Can we expect a pause in deal activity, or will the cash that private equity firms have raised in past years now be used to fuel deal-making? While this is an ongoing debate, we can all agree that deals have been — and will continue to be — impacted for the foreseeable future.
Prepare for a heightened due diligence process
COVID-19’s ultimate impact on dealmaking remains uncertain. However, there are ways you can prepare for an upcoming or in-progress deal. Expect the quality of earnings process to shift its focus toward greater scrutiny in subjective areas, such as:
- Pro forma EBITDA adjustments
- Sensitivity analysis of projections
- The overall strength of the balance sheet
- Volatility in specific industries
While both buy- and sell-side quality of earnings reports focus on normalizing historical earnings, many organizations also integrate pro forma adjustments to reflect their current level of sales volume. This is a widely accepted practice in the marketplace, but it often creates tension, depending upon which side of the deal you’re on.
As a buyer, ask yourself:
- How much credence should be given to these adjustments?
- What level of discount should be applied?
As a seller, you should :
- Consider the amount of credit you can claim, especially in a competitive process.
- Be prepared to defend pro forma adjustments with supporting calculations, and, where applicable, include customer and supplier contracts and documentation.
- Demonstrate recent performance that reflects the expected future run rate.
Provide multiple scenarios in financial projections
Detail financial projections — especially over the next 12 to 24 months — and offer a variety of scenarios and a thorough sensitivity analysis. Bridge historical results to future projections and include pro forma adjustments to provide clarity. Assess all possible scenarios that may affect the organization and provide a realistic outlook to help satisfy buyer scrutiny. This also helps alleviate the additional stress a seller may feel when being challenged on any assumptions.
The ability of the seller’s balance sheet to withstand changes in the business cycle helps inform how much leverage the organization can handle. In the short-term, a more conservative view may be warranted. In the near-term, liquidity may be a reasonable focal point, which shows whether the organization can likely meet obligations as the pandemic plays out.
Ultimately, it may be wise to maintain higher liquidity levels and excess capital. Given the current environment of business disruption, breached covenants may not be met with the same level of understanding as they were pre-pandemic.
The impact on specific industries
Industries react differently. Hospitality, travel, and leisure have been the hardest hit initially, while industries like healthcare continue to show resilience. This may trigger a domino effect in consumer spending on nonessential items, especially if the volatility and uncertainty continue.
For both buyers and sellers, consider your specific industry and how you might mitigate risk areas. While much is unknown, address potential issues up front and remain agile and nimble to increase the likelihood of a more favorable outcome. These actions may not prevent a change in EBITDA multiples or lower valuation ranges, but taking an offensive versus defensive approach helps make the most of a tough situation.
Determine the right time for a deal
Timing a deal in a volatile economy is a tough proposition. It’s a calculated risk — more so than usual — that involves educated guesswork. If you fear the downturn will resemble 2008 and the Great Recession, consider a position on the sidelines.
If you anticipate the drop and recovery to be V-shaped, comparable to the effects of 9/11, the near-term could provide appealing opportunities. After proper due diligence and forecasting, start a 60- to 90-day deal process with a letter of intent (LOI), to allow time to verify the organization’s liquidity through the uncertainty — and leave an asset poised for value creation as things turn upward.
Should the organization appear too risky during the period under the LOI, you may walk away from the deal. Despite the costs, these scenarios are often calculated risks worth the bet.
As states continue social distancing protocols and limit face-to-face interactions, remember the human element and in-person meetings are still critical aspects of the transaction process. Videoconferencing and conference calls are not always a suitable substitute. Plan for delays in deal closures and the launch of new sale processes, which may also affect the timing and completion of due diligence.
How we can help
Like most organizations, we have adapted during COVID-19 and our client service levels have continued uninterrupted. CLA is available to answer any questions about your deals or portfolio companies. We will work to understand your needs and help you develop customized solutions on liquidity, insurance, taxes, and more. Connect with us today.