On-Demand Webcast: Mergers & Acquisitions in the Time of COVID-19

July 09, 2020

Our panel of experts discussed how deals will get done during these truly extraordinary times.


Transcript

Welcome everyone. I hope everyone is safe and sound during these truly extraordinary times. My name is Alan Wink. I'm the managing director of capital markets for EisnerAmper and I'm joined by my colleague, Ethan Boothe who's EisnerAmper's national private equity industry practice leader as co moderators of today's panel. In many respects, the business world has been turned upside down as a result of COVID-19. The world of mergers and acquisitions has certainly felt the impact of the business downturn.

Alan Wink:M&A activity in 2020 was projected to post another strong year, and then COVID-19 occurred late in Q1 and deal makers suddenly hit the pause button. We have assembled a rock star panel of M&A experts to discuss the state of the M&A marketplace presently, and what we can expect in the coming quarters. Our panel consists of Andy Gilbert, a partner with DLA Piper, Barry Steiner, managing director in the investment banking group at Ladenburg Thalmann. John Von Bargen, managing director with HIG Capital, and John Ruckstuhl a managing director with EisnerAmper in the transaction advisory services practice.

Before I have each of the panelists introduce themselves, I just want to give you some data on the impact of COVID-19 on deals during the second quarter of 2020. It is not necessarily a pretty picture. Deal value in Q2 of 2020 dropped by 83% compared to the comparable quarter in 2019. In Q2 there were 2064 announced M&A transactions in the US, totaling $106 billion compared to almost 2,900 deals valued at 623 billion in Q2 of 2019. Private equity deal volume also drops significantly in Q2. Private equity deal value in Q2 2020 was 87.3 billion compared to 158.7 billion for the same quarter in 2019.

Deals led by strategic buyers also suffered significant declines in Q2. The value of strategic buyer deals was only 19 billion in Q2 of 2020 compared to 464.2 billion in Q2 of 2019. Maybe the robust M&A market will be on pause for a while, but who really knows. If you read this morning's wall street journal, you notice there were two significant transactions announced on page one. KKR agreed to buy Insurer Global Atlantic for more than $4.4 billion and Allstate agreed to buy National General for about $4 billion.

Our panel today will help us all to better understand how long it will take for buyers and sellers to become more comfortable with post COVID-19 business models, valuation, and deal terms and structures. Now I'd like each of our panelists to briefly introduce themselves and their organizations and maybe a brief comment or two on the last deal they have worked on, or are currently working on. Andy Gilbert from DLA Piper, why don't you kick us off?

Andrew Gilbert:Thanks, Alan. So as Alan says, I'm a partner with a global law firm, DLA Piper. Also among other things, I co-chair our global life sciences sector. So actually we in life sciences have been actually quite busy over the last three or four months. In terms of transactions I obviously focus on M&A and corporate finance transactions, a recent deal for our client Liquidia closed. About two weeks ago, we acquired a company called RareGen, which is a private equity backed company, and launched a follow on public offering that day which closed the end of that week. So certainly in the life sciences sector things are still humming along with different deal terms as we'll talk about, but still fairly busy and certainly in the middle market.

Alan Wink:Thanks Andy, Barry Steiner from Ladenburg Thalmann.

Barry Steiner:Thanks, Alan. Yeah, I'm a managing director of Ladenburg. We're a full service middle market investment bank, quite a bit of our practice is actually in the capital markets, which has been fairly busy and really to Andy's point, we do a lot in biotech there as well. We've seen a lot of creative deals, a lot of reverse mergers into public entities and things like that. On the M&A side, where I spend quite a bit of my time, we've obviously seen a slowdown I'm still living and dying a bit with a company that started a pre-COVID in the sale process and I guess I'll get into it a bit.

But we've experienced some of the challenges of the COVID environment, most notably potential strategic acquirers that really have left and have had to focus on their own issues, and it really opened things up, which I think is going to be a theme to some of the smaller, mid-sized private equity groups. I should note that my perspective comes from doing deals, I'm not on the sales side and that I typically three to eight, three to 10 million EBITDA sort of range is my world.

Alan Wink:Thanks Barry. John Von Bargen from HIG.

John Von Bargen:Sure Alan. Good afternoon. My name is John Von bargain, I'm a managing director here at HIG, I'm in our Boston office. Brief background on the firm. We're a global organization today that manages $38 billion in capital, really spanning a variety of asset classes. Most notably the private equity business, where I spend all of my time. We also have a large credit platform effectively lending money to middle market businesses. From a size perspective, we can invest in a business from anywhere from five EBITDA upwards to 250 of EBITDA. I specifically focus on businesses that are 10 to 35 in terms of EBITDA.

The two most recent transactions, both of which we closed domestically here since COVID hit the US, one is a chemicals business, which was a family owned recapitalization effectively partnered with that particular family very much a recession resilient business model. And then the other one is a manufacturing distributor of personal protective gear. So think about hand gloves and so forth. So naturally in this environment, the business is doing very well, and that was a corporate carve-out orphan division. I think both of those transactions are corporate carve out in a recapitalization of a family business probably represent over 80% of the transaction types that HIG as a firm both here in the US and Europe focuses on.

Alan Wink:Thanks, John. And last John Ruckstuhl who runs the transaction advisory services practice at EisnerAmper. John.

John Ruckstuhl:Good afternoon. I think most people know EisnerAmper, we're a top 20 accounting firm, leading our transaction advisory practice. We focus on deals in the middle market and lower middle market. We've seen the full spectrum since COVID hit. We were working on a number of sell side transactions, pre-COVID, some continued to do well, governmental services and industrials, and some in the consumer sector and health club space are obviously struggling depending on what state you're in and what you're allowed to open. So we've seen a little bit of everything.

Alan Wink:Thanks, John. Now I'm going to hand it over to Ethan Boothe for the first round of questions.

Ethan Boothe:Okay, perfect. Thank you, Alan. Very much appreciate it. My name's Ethan Boothe partner with EisnerAmper in the private equity world and focus really with middle market, lower middle market platform companies, operating partners, investment partners on the platform company side versus the fund side. So that's the world I'm coming from. We kind of got into this a little bit on the peripheral, but I will go ahead and ask, maybe we can go a little bit deeper. Most of the conversation today is going to be spent on current state and kind of using the crystal ball to make some guesses into the future and talk about that. But I do want to go back to mid-March, look a little bit in the rear view mirror to kind of set the stage for where we are today.

I'll ask this to the group, and if you have a perspective, love to hear that, if not, we'll keep on going But if you did look back to mid-March can you just touch on the deals that you were working on at that time? The type of deals, the type of industry that you were focused on. John, you talked a little bit about some of the ones that were working in the gym, in the health and fitness. But can you just speak to those and did most of those deals that were happening during the March get done or did you have to press pause, or did things get renegotiated, are they still in the works right now? So be very curious to get the Drew's perspective on that and I'll throw a jump ball out there at this point, and then I'll start calling on folks.

John Von Bargen:I'm happy to jump in and take the lead on that one, Ethan. I think in terms of mid-March, I kind of first look at two different types of businesses. First is those that you knew were going to be directly impacted by COVID. So pick restaurants, travel, et cetera, where it was kind of an immediate impact. And then others, like the two I alluded to that HIG closed, where you felt pretty good that they were not going to be impacted COVID. I think for a business that was impacted, it's safe to assume that 99.9% of those transactions were effectively put on pause only because lenders and equity sponsors like HIG, you have no idea where the bottom is in mid-March.

So you just needed to buy time and hopefully maintain a relationship and dialogue with that particular seller, but it was in everyone's best interest to hit pause and really try to get a sense of where the trough, if you will, assuming it is a trough and the ultimate recovery will ultimately shake out. I think for businesses that were largely unaffected, like the two that we closed and we've got a pipeline of others that were all kind of pre-COVID diligence. We've continued to pursue those transactions albeit at a much slower pace than kind of pre-COVID diligence and ultimate transaction of velocity was before March.

Ethan Boothe:Thanks, John.

Andrew Gilbert:It's Andy, I would just add to that Ethan. Some of these deals are actually getting paused, not necessarily by the buyers, but actually by the sellers, especially for those that are actually positively impacted by the pandemic. Some of the online delivery companies and those that enable them from a technology perspective. We had two deals kind of in that space where essentially the sellers, if you will felt they're being undervalued and that the world had changed and has really given them a new opportunity. So the valuation disconnect in that case was actually on the upside as opposed to a buyer kind of retreating on value. So it cuts both ways.

Barry Steiner: I'll just add is that, from the investment banking perspective, unlike Andy, I don't have too many companies that have been positively impacted by this. But I'll just point to that from working with the seller, one of the things that we've wanted to be sure about, they're very much a motivated seller and pre-COVID we were running a pretty robust process with a number of potential suitors. I think once it hit, we saw the two or three most logical buyers and decided, we got a sense of what's the certainty of closing?

I think that's the way it affected us a little bit is that we wanted to go with parties that we felt good had done a fair amount of upfront diligence. We were able to explain the ramifications of COVID and again, have more certainty around the closing than we were concerned about trying to squeeze every last nickel out of a deal.

John Ruckstuhl:It's interesting Barry, because one of the industrial deals that we started working on pre-COVID, the company is doing very well through this time, but the lead potential suitor going into COVID is not doing very well. So that's really what's hit the pause button on that one in particular. Depending on whether strategic or private equity, it's not just what the target company or that the seller is doing, but also the buyer's ability to finance the deal, and we still have not seen certainty in that area yet.

Ethan Boothe:Thank you, John, and thanks to all of you. That's great commentary, especially Andy, I like that on the flip side, on the beam revalued that you had the company that actually realized that they had a higher value through some of the service offerings that the COVID presented, very interesting. John, I think this question would be really more focused towards you and I'll let you go kind of as deep as you'd like to go. I think people are interested and like to know when this hit, just curious how your LPs reacted in the first kind of four to six weeks of the pandemic. I'd be very curious how you and your managing directors were communicating with your LPs. I suspect that was a frequently and quite robust communication and cadence was very much.

And also if you wouldn't mind touching to how you were communicating, guiding, putting together plans for your platform company management teams. If you wouldn't mind just giving a perspective of how that looked, maybe call it the first, if it were a triaged period of the first four weeks, and kind of what that looks like now that we're about three, four months into the pandemic.

John Von Bargen:Yeah, sure. Happy to feel those Ethan. I may ask you to remind me that the second and third question.

Ethan Boothe:No problem.

John Von Bargen:But let me cover these LPs first and then we can dive into I think specifically portfolio management kind of in the early innings versus kind of what's the state of affairs today. So from an LP perspective, we're very diverse across our funds and have long standing relationships. So there was I would say a fairly fluid amount of communication with respect to state of affairs. Naturally we report like most private equity firms on a quarterly basis. So it's not like you can at the flip of a switch, give them kind of what's the daily run rate post COVID of a portfolio company.

So I think what the industry has largely adopted and which includes HIG for our private equity investments is, kind of a traffic light color coding. So where are the really acute issues? Those are red, what's the watch list? Those are yellow, and of course, the green businesses that have largely been unaffected and without having a pulse on what the daily performance is to my prior example, it's a pretty helpful categorization of the state of the portfolio. I think that's been pretty helpful. In fact, we've been fundraising specifically for what will be our six flagship fund, where I spend my time through this process. So naturally a lot of communication back and forth with respect to LPs around the state of the portfolio using that traffic like categorization.

Switching gears to portfolio, naturally the first four weeks were access to liquidity. The markets were really tightening up, not surprising. So for each of our portfolio companies ensuring that they had adequate resources to weather a storm that no one could quantify in those early innings and pulling mitigating actions and levers to make sure that the business was as well positioned as it could be.

So, naturally that led to some tough decisions, like anyone's read about in the wall street journal and other press around reductions in force deferring capital expenditures, maximizing working capital levers to the extent available. So I think that that playbook was largely deployed across every portfolio company within the firm almost irrespective of where that business is from a demand and performance perspective today just because in the early weeks, who had a crystal ball, let alone knew what the next four weeks was going to look like.

I think to fast forward and into segue into the state of affairs today, I think there's using that traffic light color coding, there's really just the acute issues where there's ongoing work, but otherwise I feel like our firm like others have a very good sense of where the businesses are, where there's now growth opportunities, really starting to turn back on the inorganic M&A engine, if you will, to try to take advantage of some dislocations and really do some transformational things with our portfolio companies.

So the pendulum is very much swung, I think, to being a little bit more outward focused, and trying to capture some really compelling growth opportunities in the earlier innings coming out of this. Did I miss any other questions there?

Ethan Boothe:No, I think you've covered it well, in fact you got into my next question. John, so I'm going to let you off the hook there because I think you've covered some of that, but we will go into deal flow, different sources of deal flow that deal teams might be looking at. Obviously with private equity and portfolio groups, a lot of times your management teams through the industry groups, are also looking for potential deals. So we'll get into some of that, those lines of questions in a bit, but I appreciate the answer and I think you have it covered. Lexi, I think at this point in time, we would like to go through the first of four polling questions that we'll have for the audience.

Lexi:Great. Polling question one, as of below what do you think the biggest constraint has been from Q2 to now in closing deals? A, uncertainty and valuations. B, inability to conduct in person due diligence. C, inability to receive financing and D, cybersecurity concerns. We'll give everyone a few more seconds to respond. And we are now closing the poll and sharing the results.

Ethan Boothe:All right. So I'll just report these results out. Uncertainty valuation, 74%, inability to conduct in-person due diligence. We will be speaking to that. We also be speaking through valuations. 8% of the due diligence, 16% in the inability to receive financing. We'll be talking about deal capital, and then 2% on cyber security concerns. So maybe everyone moving from a in office to working from home environment, hasn't been as impactful as thought. So thank you all for your participation and Alan, I think I will turn it over to you for the deal origination line of questioning here.

Alan Wink:Thanks, Ethan. It's interesting that online deal rooms have been around for many, many years, but this is the first time that you're really seeing deal origination being done remotely, deal sourcing being done remotely. A question for the panel a lot of the deals that are being completed now started before the pandemic. Now we're dealing in a situation where deal origination deal sourcing has to start, with virtual meetings and webinars and things of that sort.

What do you think about the process of getting a deal done in a remote environment, and what are sort of the advantages and disadvantages of it? How do you feel about making an investment in a company where you might never meet the management team face to face? So I'll throw it out to the group and maybe John Ruckstuhl. Maybe you want to start real quickly from a due diligence perspective.

John Ruckstuhl:Yes. Thank you, Alan. It's definitely been challenging and we've had several clients ask about our capability, the travel, and it's really depending on where. I think everybody's adjusted pretty well to Zoom meetings and this is kind of face to face interaction. But as my online poker group has gotten off the ground, you can't really tell the tells through a Zoom conference and the questions are being asked about the character and how you deal with your future partners. It's definitely made the process much longer in the past where you used to be able to go out and bang through questions and answers over a two to three day period, and it just seems like the process has gotten longer because you're scheduling more frequent, shorter phone conversations, as opposed to an old day session to get things done.

The other frequent question through the due diligence process is, asking our opinion on the finance team and the accounting operations, and how are they're going to transition to a public private equity owned model. It's really difficult to do that through a webcast not knowing how they process information and just not being able to see it as well. So it is more challenging.

Barry Steiner:Alan, I'll just add to that to, to John's point regarding, regarding diligence as we do deals sort of the smaller, the deal, often the owner, the family that might own it. Maybe somebody that's rolling into a private equity buyer as well. Eventually you get around the table, you'll do a fair amount of diligence, but eventually there's like, okay, okay, we all need to get together in person and not having that ability to John's point makes a life difficult. I'm always a believer in as quickly as possible being able to get around the table and work through some, they're always two or three, or hopefully not more than five or six deal points that are best done in person.

The other point I'll make, I'll just circle back to the poll regarding uncertainty and valuations, that to me is obviously number one, the big challenge that we have now in a couple of cases that I'm working on is trying to understand are these COVID expenses or losses, can we call these one timers? Do we know if the company's going to be able to bounce back? Obviously we don't know that until time goes on. So that for us has been a real showstopper on a number of our deals a well.

John Ruckstuhl:I guess, Barry just to finish off that thought. We haven't seen that change in multiples, but to your point, it's uncovering what the noise is in the numbers and how that's going to impact overall price.

John Von Bargen:I think the only thing I was going to add Alan is, sometimes people overlook as it relates to the transaction is, oftentimes folks think about just the tactical element of due diligence and financing, et cetera. There's a fair amount of that can happen somewhat seamlessly in this virtual environment we find ourselves in. But from our perspective as a private equity firm, particularly with oftentimes family owned businesses, there is a interpersonal partnership that is developed over time. Oftentimes it's a three to six month kind of courtship getting to know one another and making sure that everyone sees eyes to eye as to how you're going to weather a variety of what if scenarios and of course have the same vision for really driving growth in that particular business, and that has to happen at some point face to face.

So the transactions we've closed in the pandemic, our businesses that we conducted a lot of that kind of interpersonal development, if you will pre-COVID. I think that while there might be a one-off situation where there would be an exception. I think for the most part, we would continue to find a way to at least to a lesser degree develop that personal relationship and conviction in the partnership via face to face as we did kind of pre-COVID.

Alan Wink:So John, just to kind of ask the question differently. So I assume you would not complete a transaction without meeting a team in person.

John Von Bargen:Yeah, I think it'd be a unique situation for us to do that. A good example is, although it's not a new transaction, but one of my portfolio companies we're going through a hiring process for a C-suite member and we had been running the process through COVID, but we were kind of at that point where we needed to have dinner and spend some face to face time with the particular front runner for that process. So we figured out a way through planes, minimizing planes and cars to ultimately find a central location to spend a half a day and a dinner to ultimately make that final decision. I think that's a good example of how we'll think about ultimately accomplishing the same task for a new transaction in this environment.

Alan Wink:Thank you. Also, and maybe this is a question for Barry Steiner concerning of the investment banking space. We all know that there are two types of buyers, strategic buyers and financial buyers. In this time of COVID-19 Barry, do you think that a strategic buyer or a financial buyer has a greater advantage or disadvantage? I think I've read that there's probably about a trillion and a half dollars of dry powder in the private equity space right now, waiting to find a home. So maybe talk a little bit about the advantages and disadvantages of each type of buyer in this time of COVID-19.

Barry Steiner:I can speak to the space that we're in, which tends to be a bit smaller than maybe what John focuses on from the investment banking perspective. It really comes down to supply and demand. So in the middle market, in the lower middle market, a lot of the strategics that we deal with are not dealt with large M&A teams. They're not built to do deals, they're doing maybe someone one-off deals here and there, and the C-suite executives are taking some of their time to get a deal done. I think we've already seen that drop off. So those strategic buyers for some of the middle market and lower middle market companies are not going to be there as often because they're focused on their own issues associated with the virus, which opens the playing field to those private equity funds that are built to do deals.

I suppose some portfolio companies of some of those private equity funds that have some of the backing to get some of those deals done. So, yeah, they're strategic, but they've got maybe the sort of private equity backing that allows them to do some add-ons. So I think that's what we're seeing. The pure strategics I think are going to back away for a bit. And then you even look at the supply and in the lower middle market, and I think realistically, what we're going to begin to see is more of a macro feeling. Everybody has different views of the virus and what the long-term effects will be in terms of people's psyches. But I think you're going to see a number of smaller businesses, family owned businesses that the owners were thinking, hey, I've got another five or seven years of this, and then I'm going to look for an exit, and often things like this accelerate, that thought process.

So I think you're seeing, and we're beginning to see that a little bit, a number of sellers that are accelerating their thinking saying, "Hey, you know something, I want to get to market a little sooner. I don't know what this virus is going to bring. I don't know what might be behind it that's similar." So I think you're going to start to see a greater supply of potential sales site opportunities. And again, I think the advantages, at least in the lower middle market now will be with those private equity funds that are built to do deals.

Alan Wink:Thanks, Barry.

Andrew Gilbert:It's Andy, just to follow up on that, and there's really two types of strategics and Barry laid out pretty well. It's those that have a war chest and are in the business of acquiring companies are actually poised to do very well here, because they're not relying on leverage like the private equity firms have been in the upper middle market, if you will. So they can actually move much more quickly. But I agree with him, it's a narrower field now among the strategics, because those that have been kind of opportunistic and picking off a company here to a year, those companies are going to be a disadvantage. But those that have an M&A team and that's part of their business model, they're actually going to be highly competitive in this M&A climate.

Alan Wink:Just to change gears just for a moment real quickly and talk about deal flow, because I guess the traditional channels that we all look at for deal origination, whether it's conferences or trade sector shows or whatever it might be, being out in the marketplace no longer exists. Where are you going to find your next deal? How's it working? You're not going to meetings, you're home more often, you're picking up the calls from people who have opportunities to show you. How do you look at your deal flow? Has your deal flow slowed down since the pandemic started or you're not seeing any effects?

John Von Bargen:I'm happy to jump on that one first, Alan. I think it depends. We're fortunate given the size of our institution and our tenure that, we have a bit of a deal flow engine with thousands of contacts. I've got a number of colleagues in our business development group in a couple of different offices that are constantly reaching out to those contacts. And of course, the larger middle market banks, it's kind of a two way street. So they're constantly want to show us opportunities so that we can ultimately engage them to sell our businesses.

So we're somewhat fortunate in an established deal flow network. But I will tell you that in this environment the deal flow has changed dramatically. And not surprising, one of the things that I'm responsible for is managing some of our investment banking relationships and one that comes to mind, and I'll quote a couple of weeks ago said, when we went into the pandemic, we had about 120, I think it was 125 mandates. Whether it was capital raise, minority equity or control transactions, and think of this as all sub hundred million dollar EBITDA sized businesses. And this individual said, "Now we have two."

So they effectively hit pause on almost all of those. Those are clean businesses that were up into the right pre-COVID. So I think as we think about deal flow, what we're seeing right now is there's kind of the legacy activity that predates COVID, some of which we've closed and optimistically will close some additional transactions that were really diligenced pre-COVID. I think a lot of the processes now that we're starting to see are tougher situations where perhaps a lender is starting to force a effectuate change in the business, or going back to the traffic light comment I made earlier, those sectors that really have been impacted the most severely.

So there's a change that's required just given the fundamental dynamic in that particular industry, but there's been a significant shift in the mix and the type of deal flow in light of the pandemic. And just a lot of those cleaner businesses saying, "if I don't have to sell now, why would I?" Because there's such turbulence in the market, the lack of financing, uncertainty around valuations, like the polling results suggest. So why not just buy some time and wait, unless there's another motivation at play there that requires that seller to do something sooner.

Alan Wink:Any other panelists have anything to add to that?

Barry Steiner:Yeah, I'll just note regarding deal flow from my perspective, Ladenburg is somewhat unique. We're owned by the Advisor Group which is actually private equity owned. But Advisor Group and Ladenburg now are heavily into the independent financial advisor business. So we probably have about 11 and a half thousand financial advisors around the country that see opportunities as well, or our money management folks. So they've got relationships with quite a few business owners and things like that. So we're always trying to take advantage of that.

But yeah, to John's point, I think this is really where you try and take advantage of relationships built over years and reach out. But for sure not being able to get on a plane and spend three days in the city knocking on doors makes life very difficult.

Alan Wink:Okay, at this point, go ahead, Ethan.

Ethan Boothe:Yeah, no, I was just going to add actually from our perspective, large advisory accounting tax firm. It's interesting in being in the private equity is most of my clients over the last probably six weeks just a lot of outreach, much more than normal from private equity folks that are responsible for deals. So I'm sure John, we had talked about this previously, but I know that probably some of the things you might've looked at that didn't close for whatever reason in the past.

I think that a lot of the private equity groups were kind of destined off that Rolodex and maybe going back to that management team and certainly checking in on a deal that didn't get done. And really I think a lot of the business developments and folks that are in the deal, people out there are reaching out to groups like ours and private equity leaders for groups like ours and saying, "What are you hearing? Do you even have existing clients that are good clients that might be looking for a transaction?" In a lot of instances, private equity groups that might've been a control position only since COVID have now changed their position, and they want to let us know that they have a couple more arrows in the quiver to a certain extent and might be willing to take on minority deals or other types of capital financing.

So we've certainly been receiving a lot more of those phone calls, Zoom webinars over the past six weeks, specifically in the middle market, lower middle market than before and I'm sure we're not unique in that sense. I don't know, John, if you have any commentary on that.

John Von Bargen:No, it's an excellent point, Ethan and one I failed to mention. But in fact, all the partners and principals we've been kind of cultivating lists over the last 24 months of those businesses that found really interesting to build a thesis around good management teams that didn't ultimately transact, and so hopeful that will ultimately yield additional transactions this year. In fact, one just as you were speaking, I was thinking of is a great kind of case study where the seller decided to go down a path with another private equity firm, that private equity firm reacted differently in early March to COVID.

We reached back out, had a good relationship, and that seller, I think somebody made this point earlier that, the seller kind of had a different expectations with respect to a transaction at that point and wanting to kind of move on from the business. So we've kind of come up with a very creative financing structure to ultimately facilitate that business. It's one we're really excited to own, it's growing through COVID and we think has really bright prospects. So that's a deal hopefully that'll get closed in August and it's a great example of effectively mining that list from the prior couple of years of deals that haven't closed that you can kind of rekindle relationships and ultimately get something done.

Alan Wink:Right. It sounds like John, on that one, you guys had already had the time, whereas you might be a little bit more reluctant to start something fresh without having that human element. You guys had had that from a prior, so going back just makes a ton of sense.

John Von Bargen:Yeah, exactly.

Alan Wink: Hey Ethan, why don't you continue the questioning with concerning valuations since that was a topic that certainly came up pretty prominent in our first polling question?

Ethan Boothe:Yep. Absolutely, valuation it's everyone's favorite topic and everyone just has it absolutely nailed right now. Obviously say that tongue in cheek. So I will throw out only one valuation question because I do want to move through the rest of the topics, but what I know depending on industry sector, it all depends. But if you have a perspective you'd like to speak on then I'd love to hear what you have to say relative to where do you see valuations heading into 2021.

Obviously, the trailing 12 month model doesn't really work as much in a COVID environment. And Andy, you mentioned one earlier that had been revalued on the upside, which is a positive at least for that potential seller. But how has it been? Have you started to see buyers and sellers kind of become aligned yet on valuations, and when do you think we may, we may get there if we're not there already?

Andrew Gilbert:Well, as you say it does depend on the industry and certainly on if there are public comps, overall the capital markets have held up pretty well. So you're looking at that and in some cases as the proxy. But I think to the points made earlier, buyers and sellers have other motivations and especially with family owned businesses, they may be looking at this and just willing to take some chips off the table now as opposed to waiting for the other shoe to drop, especially now. We actually saw a little bit of a uptick and then it seems to be back on pause here as the states have started to rethink their reopening plan.

So I think it's just too early to tell, but I think there's general hesitancy on both buyers and sellers parts to go one way or the other, frankly, I think there's waiting and seeing in many cases. I would say to the point though in terms of deal process, if a deal has legs and everybody's reached an agreement, and then there's a meeting of the minds, everyone's focused. There's not much else, no one's getting on planes and they're not distracted. Everybody's energy is into that deal.

So you're seeing them happen, I think on average a little bit faster because of that overall focus. The lawyers are focused, the bankers are focused and all the other professionals are all over it, as well as the management team. So once there's a meeting of the minds, people were actually hustling fairly quickly.

Ethan Boothe:Andy, I've actually heard that quite a bit as well. I know that John Rochdale said that things are taking a little bit longer. I have heard that since COVID, you can get ahold of people and they're going to be there. They're sitting at their homes, they're similar. So you can kind of get everyone on that web call and it might be even easier than before to get people maybe not in the same room, but obviously the same virtual room as it were. So kind of definitely aligns with what you're saying about once things gets going, it's easier to get people moving together. I believe we're up to another polling question. Lexi, if you could take us through polling question number three or the next one that we have, that would be great. It's our second polling question, I guess.

Lexi:Okay. What quarter do you expect deal activity to return to pre-COVID levels? A by the close of Q4, 2020. B, by the close of Q2, 2021. C, by the close of Q4, 2021. D, by the close of Q2, 2022. E, by the close of Q4, 2022, and F, 2023 or beyond. Apologies about that. We have closed the poll and share the results.

Alan Wink:So I guess when you look at the results here it seems that about 60% of the people think that we'll get to some sense of normalcy by Q2 of 2021. So that's a pretty optimistic, I like that. Let's talk a little bit about capital accessibility. Looking at leverage that the banks are willing to participate in today's deal environment. Maybe a question directed it at John Von Bargen, about what kind of leverage are you seeing in the deals that HIG is contemplating right now?

John Von Bargen:Fortunately leverage is coming back. If we had done this panel, Alan, six weeks ago, or maybe even four weeks ago, I would have said that it's largely an illiquid market right now. But you as I was reflecting on kind of the early innings to Ethan's question earlier around portfolio management lenders were going through the same dynamic and still are to some extent, which is really trying to get a sense of the health of their portfolio, where they're going to need reserves. So naturally really conservative with respect to advancing into new transactions.

I think the other dynamic that a lot of lenders are faced with is, there's a large secondary market, and so for 8% type returns they could go and invest in a GE bond just to give you an example where you have liquidity, the risk profile is much lower and so they have optionality in a pretty liquid market to the extent that their LPs mandate that.

So the market's been very slow, but as evidenced by the transactions that we've closed, there is credit out there. I think it is improving, but it is far from being at the pre-COVID level in really all respects. Number of parties that are interested in financing a transaction, the quantum of leverage that's available in terms of multiples, and of course and just pricing. I think lenders are looking at particularly in the lower middle market, just the risk return profile of being a cash flow lender. I think that's fundamentally changed, I think it's going to take into 2021 to ultimately see real recovery there. If I was a betting man, I'm not sure it'll get back to pre-COVID even that quickly, just given the inherent choppiness and various lenders portfolios rather.

Alan Wink:Any idea what, if I looked at a deal that was debt priced in February versus today, it's at 100 basis points more expensive, 150 basis points. What do you think it is?

John Von Bargen:Yeah, it's a great question and unfortunately, the sample size that we track isn't as large as we otherwise would like. But if I had to kind of take a plain vanilla company pre-COVID versus post, I would say leverage levels are down one to one and a half turns and pricing is probably up one to two or one to 200 basis points. The competitive tension that you ultimately want to achieve in a financing process is really lacking as well. But I think that goes into the pricing range that I had articulated earlier.

Alan Wink:Any comments from any other panelist relative to the leverage in deals that they're working on now?

John Ruckstuhl:I agree with what John said, that's sort of exactly what I've heard from the market as well on pricing and leverage.

John Von Bargen:I think one thing I would add and we may get to this later is just creativity around deal structure, and I think this is reflected in some of the transactions that we've closed and we're working on right now is that, the great recession, the.com bubble, these are all reflected the same as that. There are creative means of ultimately bridging a financing shortfall, whether it's earn-outs or seller financing type of structures. So I think the frequency and the depth of those two kind of structuring tools, if you will, to bridge this financing gap, I think will become more prevalent. I'm sure, Andy, although you spend more time in life science, I'm sure you've probably seen some of that or will.

Andrew Gilbert:Absolutely.

Alan Wink: Well, John, it's actually you're leading right into the next question. So we'll talk about some of the deal terms and deal structure, now I'll go ahead and get right into that. Andy, I think I'd start the question with you how deal terms and agreements changed since COVID-19 and let's talk, go ahead and just, your perspective on the change, including earn-outs and seller financing. And then we could go around more and after you give your perspective.

Andrew Gilbert:The way to think about this as are a lot more focus on what otherwise we're typically fairly benign and otherwise general representations in the purchase agreement. So there's money much more focused on the representations around business contingency and continuity planning. The seller's relationships with his customers and the suppliers, collectability of AR, as well as compliance with labor laws, given riffs that have been occurring. The IT reps around cyber are certainly getting a lot more focus and then you've got new ones around compliance with Cares Act and the PPP programs and the main street lending programs that many companies have taken advantage of through the federal government program.

So you're seeing a lot more diligence around things that you wouldn't just spent as much time on before. Just given the nature of what's going on with these sellers, that's the kind of on the rep and warranty side, and then in the period between signing and closing, as you're trying to get through regulatory approvals, et cetera, there's operating covenants that the seller needs to abide by in order to operate know and be compliant so that the buyer gets essentially what they bargained for when you ultimately close.

There's a lot more focus around what that seller is going to do in that interim period. Are there going to be covenant defaults with the lenders? Are there going to be a need for cash infusions? So you're really digging into the operations of the seller in a way that you might not have needed to as in depth as prior to COVID. So you're doing a lot more diligence on what's going on with the underlying business. And then that results in structural changes such as earn-outs, which are becoming much more prevalent. Certainly seller notes where they take back some debt in order to get a transaction done, ways of kind of bridging the valuation gap if there is one as John alluded to.

Alan Wink:Andy, real quickly, one of the questions that was pulled by the audience, since we're talking about earn-outs is should we expect to see an increase in amount and term for earn-outs?

Andrew Gilbert:Certainly they'll be more frequent. I don't think they were prevalent, frankly, going into these last few years. Pre-COVID, I think people were just getting the cash and moving on. So I can't answer that necessarily if it's going to be more, I will tell you that certainly as John indicated in the financial meltdown and the .com issue in those periods, those earn-outs are nothing like what you're saying now. You're seeing significant portion of the purchase price being tied to earn-outs.

Usually we've very wide bands of performance. So that you there's something for the sellers within that range, but it's a wide range of financial results that would trigger the payments.

John Von Bargen:I was going to add Andy to your point. I think you're spot on. If you talked about an earn-out pre-COVID, you probably were not going to be the ultimate suitor to be buying the business when you're really looked upon unfavorably, but it's obviously an entirely different marketplace now. So the question ultimately depends on what's the comparison, too, and if it's kind of late last year, even January, February it's kind of night and day.

I think terms are ultimately unique to every particular transaction where you're trying to strike a balance of being fair to the seller such that that earn-out can ultimately achieve so long as the business that is being represented and to your point, that you bargained for is ultimately reflected post-closing and kind of the deliverable as to how it performs. But no question, the quantum of earn-out is definitely on the rise, just given the uncertainty around valuation and then the lack of financing in the credit markets.

Barry Steiner:Guys, the only thing I'll add to that from my perspective is, what we've seen is as really the advantage shifts to the buyer, we're just seeing that much deeper diligence we're seeing more time spent on key items with respect to earn-outs. They're still out there, what we try and advise our seller clients is obviously you could stay away, stay away, you potentially lose control of that. So in exchange for that, you're just going to have to spend that much more time diligence and be able to prove out things in a clearer fashion. So that's really what we've experienced is just, some deeper diligence than I would have expected to see in the past.

Andrew Gilbert:Yeah. And that creeps into deal terms too. The sellers are going to want to make sure that they can hit there and out, but they've handed the keys of the business to somebody else in many cases. So you need to negotiate deal terms, covenants where the buyer is going to do certain things in order for the sellers to make that earn-out, whether it's control of budgets or not cutting marketing budgets, or what have you.

And that's a little more challenging now I in a COVID environment to really negotiate all those kinds of things that you want to have control of as a seller to hit your earn-out when you sold the business to a buyer who may have their own issues. So that's a challenging negotiation, but one that's generally going on.

Alan Wink:Andy, while we're talking about a deal terms and you mentioned before previously, the PPP loans and we all know that a lot of companies receive them and companies will be dealing with the issue of forgiveness of those loans over the next three to six months. One of the questions posed by the audience, how are you seeing PPP and other loan proceeds being handled in the context of balance sheet presentation and working capital purchase price adjustments? Have you seen anything like that?

Andrew Gilbert:Well, most of these deals that I've been working on are cash free debt free, and there's usually just a covenant that they get paid off as other that would at closing. So buyers doesn't really have a lot of patience for it in the deals we've been working on of late. So it's just a payoff from our perspective, like any other indebtedness at closing, that they're not waiting around to see if it's forgiven or not.

Andrew Gilbert:Especially a lot of the buyers. It's good.

Alan Wink: was going to say, Andy, we want to get to our next polling question, but make your comment, please.

Andrew Gilbert: I was going to say a lot of the buyers, if they're PE based they'd just frankly, we had been advising many of their own portfolio companies not to take these loans out in the first place. So they just don't have a lot of patience for these loans. And they're not that big to move the dial in many cases.

Alan Wink:Thank you. Lexi polling question number three.

Lexi:To what extent do you agree with the following statement? I have been able to conduct due diligence on deals to a satisfactory level during the pandemic. A, strongly agree. B, agree. C, disagree. D, strongly disagree. We'll give everyone a few more seconds to respond, and we are now closing the poll and sharing the results.

Alan Wink:So it seems that most of our respondents thinks that a due diligence has been able to be done effectively during this time of remote due diligence. Just a quick question for John Ruckstuhl. John, have you seen any unique ways that companies have been handling due diligence? I've heard about companies doing sort of videos of their operations, narrated by CEO's or other C level team members. Have you seen anything different and unique from companies you're working with or you've heard about in the industry?

John Ruckstuhl: No. I've heard about some of those as well. I have not seen any, it is been a lot of Zoom type meetings, trying to share information and inevitably dealing with an internet breakdown or other hiccups. But I would say, the other thing is people have been doing calls more off hours, and more and more kids and dogs in the background.

Alan Wink:Any of our other panelists have any unique due diligence stories for the last four months or so?

John Von Bargen:I wouldn't say unique. I think the one theme that does seem to be gaining traction and perhaps it'll be more efficient in the long run is that management teams are doing prerecorded kind of Zooms with their management presentation. So as opposed to pre-COVID where you'd kind of get your allotted four hours individually as a deal team with a management team, now, some processes are doing an hour and a half prerecorded and asking for bids based upon that. So you're not necessarily getting as much individual time and attention with the team.

It's obviously a lot more efficient for the management team, but from my perspective doesn't necessarily give us the airtime that we otherwise would like to get a lot of our questions answered. So we have to do that through other means earlier in the process, but that's really the only nuance that I would kind of be quick to highlight.

Ethan Boothe:Hey, John, and we're going to get to one last polling question and then we will wrap here probably in the next couple of minutes. But I think that's interesting. I did want to ask just real quickly, that's one that you've seen for management teams, but when you talk about in the time of COVID and everyone's pivoting and looking for kind of competitive advantages and doing things differently, is there anything that you guys feel like your business, your practice, your organization has done to pivot that you do feel like is a best practice and might replace a general standard business practices that would replace that, that other business practices that might never come back from an M&A perspective? I'll kind of throw that out real quickly to you and the team for last comment. We'll hit the last polling question and then we'll sign off.

John Von Bargen:I assume Ethan it was directed to me?

Ethan Boothe:If you'd like to take it, John, that would be great.

John Von Bargen:Sure. I think probably the one that I think was already starting to change pre-COVID is using to replace getting on planes, trains, cars, to conduct a lot of diligence. To my earlier point, I still think that particularly lower middle market, a lot of it's so interpersonal that there will always be a requirement for face to face, but will Zooms just given the adoption and comfort level that everyone now has in light of this pandemic, will that replace 40%, 50%, 70% of the travel? I think it will definitely impact some of it, and I think we're not unique there. It's not like a process that we've changed, I think it's more just the marketplace and process that will fundamentally change in response to this.

Ethan Boothe:Great point. Any other perspective?

Barry Steiner:Yeah, I would agree. I think anything good that's come out of this is the acceleration of technology and what we all do for a living, but yeah, to John's point even more important than on the investment banking side, is that we need to be in front of people and this has made life difficult, but yeah, the use of technology is for all of us obviously been accelerating.

Ethan Boothe:Great. Andy, I don't know if you had commentary, if not, we'll go to our polling question.

Andrew Gilbert:Yeah. Why'd you go to pull that question. I don't have a lot more to add to that. I would agree with all that.

Ethan Boothe:Perfect. Lexi, you want to take us through the last polling question please?

Lexi: Great. Which of the below sectors do you think will present the biggest opportunity for investors in the six months following the end of the pandemic. A, healthcare. B, technology. C, real estate. D, energy. E, travel and hospitality. E, retail and G, food and beverage. We are now closing the poll and sharing the results.

Alan Wink:Hey, surprisingly people were bullish on real estate. It's looks the two areas are real estate and technology. Very, very interesting. So with that, I'd like to thank our panelists and thank you, Ethan for co-moderating with me and look forward to seeing everyone in person in the near future. Thank you and have a wonderful day.

About Alan Wink

Mr. Wink assists clients with capital budgeting, capital structuring and capital sourcing. He has worked with many tech and life science companies on developing the appropriate capital structure for their position in the business life cycle.

About Ethan M. Boothe

Ethan Boothe is the Principal-in-Charge of the firm’s fast growing Texas Region, and the Private Equity Industry growth leader nationally.

About John Ruckstuhl

Mr. Ruckstuhl is a Managing Director in the Transaction Advisory Services Group. John has over 20 years of experience advising private equity and venture capital firms, as well as their portfolio companies, on domestic and international transactions.

Have Questions or Comments?

If you have any questions, we'd like to hear from you.