Q: “Is your office seeing much business merger and acquisition activity right now? What sorts of things are being done differently in light of COVID-19?”
May 20, 2020
Answered by Marc Zaslavsky
LP has quite a few active business M&A right now, more than we were expecting, and mostly for essential businesses that have remained operational during the shelter at home order and have not been severely impacted by COVID-19.
We expect that many more companies will come to market soon. Business owners who sweated through the Great Recession did not expect to face existential challenges again, and many will be ‘throwing in the towel’ in the coming months rather than try to rebuild yet again. This will create meaningful opportunities for competitors to pick up otherwise sound companies at favorable pricing.
In terms of special considerations in light of COVID-19, much of this will be part of enhanced due diligence. Buyers need to look more deeply into a target’s supply chains – are key suppliers fully functional, or are they drawing down inventories to the point where supply interruptions will be seen later? Buyers need to review the ability of customers to cancel material contracts under force majeure clauses. They also need to understand the target’s ability to pass along increased production costs to customers – long term fixed price contracts are particularly problematic in times of economic uncertainty. Understanding the continuity of the target’s workforce is important. If there have been lay-offs and furloughs, understanding that the target conducted those in accordance with new rules is important. Were workplace incidents of COVID-19 handled in accordance with HIPPA privacy rules? As employees returned to work, did the target follow CDC and state and local legal requirements for the provision of PPE? Does the target have insurance appropriate to the new risks associated with operating in a COVID-19 environment? Due diligence tasks as basic as site inspections of a target may not be possible. From a financial standpoint, even for essential businesses that continue to operate, erosion in the order base or backlog will require closer examination as the consequences of reduced order flow may not be immediately apparent. Accounting teams need to go beyond their typical validation role and use their forensic hats to identify nascent trends. Finally, if the target secured a PPP loan or other government benefit, did the target make lawful certifications of need in their loan application? Did they use loan funds for prescribed purposes? And did they correctly calculate the portion of the loan to be forgiven? There is also the need to understand PPP loan repayment obligations upon a change in control of the target.
The key to a successful acquisition has always been solid operational, financial, and legal due diligence. COVID-19 has created numerous and varied special considerations. I would not be exaggerating by saying that a due diligence checklist could nearly double in length as a result of COVID-19. All that said, As economic activity resumes, there should be a reward for the added effort in terms of more acquisition opportunities at better pricing. On the other hand, on the sale side, a truly solid company coming out of COVID-19 may attract even better pricing as sidelined private equity money awaits opportunities to deploy capital safely.