COVID-19 and M&A

The impact of the pandemic on private equity M&A activity

Normally, I have experience in the topics and situations I write about. This is different, because this situation is unfolding in real time, and it is unlike anything we have experienced in at least 100 years. By the time you read this, much of what I write about will be more clear, and my viewpoints could be proven wrong.

The pandemic and economic shutdown began negatively impacting businesses in early March, earlier if you were sourcing from Asia. The full effect of the pandemic and length of time it negatively impacts the U.S. economy will not be known for months, and possibly well over a year.

Investors like predictability, and not knowing the totality of the impact or when a recovery will occur creates tremendous uncertainty, reflected every day in the wild swings in the stock market. It appears to overly react in both directions to positive or negative news, and it is manipulated by The Federal Reserve’s bare-knuckled approach to resisting a full recession and programmatic trading by computers that make virtually every trading decision on Wall Street. That’s the public equity market.

In the private market, its virtues are that it’s private, slower to react — thereby avoiding market volatility — and managed by professionals. As a result, it has been more rational, more steady and a better indicator of where the economy is going.

From a private equity perspective, the pandemic and recession have reset rational behavior and set the stage for the next opportunity. Ten-year record-breaking expansions are a wonderful thing, as all boats rise. But when all boats rise, it makes it more difficult for private equity investors to discern between truly unique forward-thinking value propositions and outstanding management teams, and those also-ran value propositions and reactive management teams repackaged to tell a different story.

A recession makes this more clear, and good businesses are rewarded for their perseverance to improve during expanding economies when it’s easier to coast and enjoy benefits without the hard work.

The businesses many private investors want to invest in are battle-tested, and that is worth a lot. There is still almost a trillion dollars of private capital waiting to be invested. Banks remain well-capitalized and ready to lend thanks to the gloves-off approach by the Federal Reserve to resist a wider and longer recession. The playing field is reset, with different investment priorities needing to be matched with the tremendous amounts of capital waiting to be invested.

M&A activity took a two-month hiatus and is now backed up for a quarter or more as the supply of businesses winds its way through the pipeline. Many businesses that were in the market to be sold in Q1 could not obtain bank financing as banks took a wait-and-see approach, and businesses originally going to market in Q2 are waiting to maximize PPP loan forgiveness and assess buyer appetite for new acquisitions.

But the real winners are those newly recognized, game-changing businesses that went a few rounds with the COVID-19 pandemic and won. They will be found quickly and receive a well-deserved premium from opportunistic buyers with cash to burn. There are also businesses that will never recover, and potential buyers will seek to take advantage. This pandemic-led recession is no different than any other in that it resets the M&A cycle, but it’s different in that consumers, business professionals and economic prognosticators are not dealing with the same variables and economic indicators that have served them so well in the past.

Jeffrey Kadlic, co-founder and managing partner of Evolution Capital Partners LLC, is an alumnus of Crain’s Forty under 40 and an EY Entrepreneur Of The Year finalist.