Takeaways from the Virginia State Bar Discussion: Capital Raise or Sale
Last month, Cherry Bekaert’s Private Equity Industry Practice Leader Scott Moss shared his insight regarding 2021 marketplace predictions on a panel put on by the Business Law Section of the Virginia Bar. Scott and his fellow panelists – two M&A attorneys and an investment banker – discussed the impact and aftermath of COVID-19, 2020 trends, and predictions for 2021. While all four experts are devoted to the deal market in their professional lives, they each offered a unique perspective to help guide middle-market businesses in raising equity capital and considering a company sale or merger.
To listen to the full panel, please click here and fill out the short registration form. Below, we’re sharing a few key highlights.
COVID-19 Impact
- Even amid COVID, new businesses were starting at a fast rate. As of November 30, 2020, there were 14,000 more LLCs set up than in 2019.
- “2020 has been a phenomenal year for start-ups. I think one of the things COVID has proven from a public policy standpoint, is that the investment and resources and infrastructure that’s been put in place to help small business and startups have really excelled during the past several months,” said Jeff Mitchell, Attorney at The Mitchell Law Firm.
- COVID is not a liquidity crisis. It’s different from what we’ve experienced before in financial downturns. COVID is sector-specific in that some industries have not been impacted much at all. Others – such as travel, hospitality, and restaurants – unfortunately, have experienced a severe impact.
- The platforms are in place for us to be at a new normal, working remotely. Companies have been able to pivot and function virtually. While the process to complete deals may take a little longer (five to six weeks rather than three to four weeks, on average), management teams are able to devote more time to focusing on their business now that their travel time is freed up. Our panelists have witnessed that when there is a committed seller and a committed buyer, they can get hurdle bumps in the road.
- “‘High-quality deals’ have largely not been impacted by the pandemic, or there is a very explainable story in terms of what the impact was due to the pandemic. Those companies have generally been trading at pre-pandemic levels if for no other reason than the scarcity value. If you’re fortunate enough as a sell-side banker to have a good company on the market, there’s the remaining imbalance between dry powder and good quality deals on the market,” said John Dickinson, Managing Director at Dickinson Williams & Company (investment banking).
Trends
General Deal Trends
- Investors are putting forth investment policies to address minority/female-owned businesses. New funds are targeting specific founder groups or re-focusing existing funds to focus more on these businesses as well as green deals. The objective of these investments is the desire to make an impact.
- As we’re looking at diligence, there are a lot of questions surrounding how companies have responded to COVID. Are they securing funding under the CARES act? Taking advantage of payroll deferrals? Were there furloughs/did they do headcount reductions? What’s the visibility of the revenue stream returning to pre-COVID levels? Lenders and investors want to know about it. What’s considered a new financial metric is EBITDAC (Earnings Before Interest, Taxes, Depreciation, and Amortization, and Coronavirus).
Venture Capital/Startup Trends
- The virtual pitch may continue to be a challenge as messages don’t always come across well on video, and there is the potential for technical difficulties. But it’s likely here to stay.
- We’ll likely continue to see more active mentor engagement in the start-up environment.
- Family office and private investors continue to emerge and become active in deals.
2021 Predictions
Earnouts
- “I expect we will see buyers propose more earnouts than we saw in 2018 and 2019. For businesses that have been impacted by COVID – even if they have a very plausible, explainable story – if I’m on the buy side, I believe that an opportunity is there, but I want you to show me. One of the ways to show us is to structure an earnout. My guess is that sellers in general will be more open to earnouts than they would have been a year or two ago,” said Mitchell.
Deal Activity
- Due diligence will probably take longer in 2021 mainly because it’s being done remotely, even though there’s more dry powder entering the year. We’ll see more focus on profitability and cash management.
- Sales and use tax is a key issue in almost every transaction, especially in the post-Wayfair era. States are now able to move forward aggressively in collecting what they view as their “fair share” of taxes. Seek an advisor who can examine your sales tax exposure and take the necessary steps to ensure your company meets economic nexus and threshold requirements for each state.
- Another factor in every transaction is Rep & Warranty Insurance.
- Add-on acquisition trends emphasize the importance of lower middle-market deals for private equity funds. They represented 72 percent of the total number of year-to-date deals by the end of September. 2020 emphasized private equity’s ability to pivot and move to those add-on transactions rather than just focus on platform deals.
Appetite of Banks for Financing Private Equity
- “In general, we’ve seen that debt multiples have gone down more than total enterprise value multiples. So logically, what we’ve seen is 5-10 percent more of the purchase price has gone to the form of equity versus debt compared to 2019,” said Dickinson.
- “The one thing that’s different here than the last economic downturn is the advent of the private debt market. That was really an outcome of 2008-2010 when banks weren’t lending. We saw all these groups set up their private debt funds which filled a significant void in the marketplace and gives alternatives for something other than pure traditional senior bank lending. I think private debt funds are here to stay and something that helps to fill that gap in the debt side of the balance sheet. And in some cases, they can do some things differently than a large bank can. More of our clients are looking at this,” said Moss.
