M&A Financing During the Pandemic

The pandemic has put lower middle market business sales and acquisitions on somewhat of a roller coaster ride. Deal volume declined sharply in Q2-Q3 and came back strong in Q4. Valuations have remained strong throughout the pandemic, at least for COVID-resistant businesses. Though there was a slight Covid-effect in Q2-3.

In terms of M&A financing, capital structures shifted to slightly more less debt during 2020, before edging back up to pre-pandemic levels in Q4. To compensate, the capital stack was being filled in with more buyer equity and more rollover equity.

Interest rates are still low and banks keep lending, but they have pulled back slightly. Lower middle market deals have typically had senior debt of around 3x EBITDA. According to GF Data, that ratio dipped to 2.7-2.8 in Q2-3 (the lowest level in 5 years) and returned to 3.2 in Q4 2020.

GF Data reported an uptick in buyer equity from 2019 to 2020, from 46.1% to 49.1%. We are still seeing buyers bring more equity to the table than pre-pandemic, and showing more interest in seller rollover equity.

Rollover equity is when a business owner retains a minority stake in the enterprise. For businesses valued between $10 million and $25 million, rollover equity accounted for 13.9% of deal funding in 2020.

At the start of the pandemic most of us were expecting to see more earnouts (contingent consideration) in transactions, but that hasn’t materialize. Because demand for acquisitions remained high during the pandemic, most sellers have been able to avoid earnouts.

If risk and uncertainty subside and interest rates remain low, we should see a return to more typical M&A funding levels in 2021.

For further information on M&A financing, or to discuss a current business sale, acquisition or valuation need, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com.