2020 was a year characterized by challenges, but entrepreneurs, companies and firms at all levels and lifecycle stages also seized on many opportunities.
Generally, there was a great pause when the pandemic made its way to the U.S. and governments responded by requiring what they deemed nonessential businesses to close. That created not only physical limitations to transactions but also gave almost everyone pause as they dealt with the uncertainty of how to proceed in such unprecedented circumstances.
But the M&A world adjusted. Deal volume picked up, helped at least in part by another type of uncertainty: the specter of potential tax changes that could double a seller’s tax burden in what is typically a once-in-a-lifetime liquidity event.
Ultimately, dealmaking volume was only slightly off the pace. According to Pitchbook’s 2020 North American M&A Report, activity on the continent this past year dipped below the $2 trillion mark for just the second time since 2015. Companies completed 12,265 deals, down from 12,930 in 2019, for a total of $1.7 trillion, below the previous year’s mark of $2.1 trillion.
While uncertainty remains, the dealmakers we spoke with are optimistic about this year’s prospects. Buyers will have to tangle with an increasing number of other buyers, many of which seem to be deploying more creativity in their deal structures to win bids. Sellers, conversely, are making the case that any softening in their numbers is the result of what is essentially a natural disaster, and once the dust settles, their strength — and value — will be evident.
In the earlier stages, established entrepreneurs had the advantage as investors shied away from the new and unknown in favor of the tried and true. Still, hard decisions had to be made in many established ventures, and some were asked to reimagine their business for a new economy, one inextricably shaped by the pandemic.
The tide promising to raise all boats may be the trillions of dollars sitting on the economic sidelines. Acquirers are eager to get back in the game, and with technology aiding search and diligence, there’s an opportunity for smart buyers to come out ahead.
What follows is a sampling of outlooks from dealmakers across the M&A spectrum, offering their perspectives on what happened and what’s to come in a year still colored by COVID-19.
Rush to quality
Deal competition heats up, requiring buyers to get creative
While the pace of M&A was slower during the late spring and summer months of 2020, Sara Clevenger, a principal at Blue River, says many buyers remained motivated to look at opportunities and continue their acquisitive strategy.
“It really ramped up the beginning of the third quarter with buyers hungry to look at somewhat of a compressed supply on the supply side, looking at deals and looking for quality deals,” she says.
For their part, sellers — arguing that they shouldn’t be penalized by buyers for what they could not control — pointed to any softness in sales that affected revenue and profitability as an aberration. Motivated buyers with capital to deploy remained interested but needed to mitigate risk, which they did though tools such as deferred milestones to achieving agreement on value.
“That’s been a trend in the recent couple of years, but it was certainly leveraged quite a bit over this past six months,” Clevenger says.
Sellers became hesitant as 2020 came to a close, as many looked to transact before any new tax changes became law. That accelerated deal announcements and closed transactions.
“Coming out of the fourth quarter, we have a record number of concurrent letters of intent under diligence across deals both on the buy side and the sell side,” Clevenger says. “So the trends going into 2021 are markedly even more optimistic in terms of deal activity than they were this time last year.”
This year, buyers are expected to be challenged by a competitive buyer market.
“There continues to be this $2 trillion-plus in overhang of capital power — just a tremendous amount of capital that needs to be put to work, looking for quality deals, looking to be able to adjust in the accelerated transformation that 2020 brought on the heels of some of the digital uplift and change,” she says.
Buyers, then, may continue to utilize flexibility in the capital structure, explore minority investments as a way into an investment and then tier that majority recap or that full purchase for a later successive event.
“One of the biggest things we’re seeing is creativity, flexibility in addressing the capital structure in order to really to achieve the goal, which is to get deals closed,” Clevenger says.
Weighing the impact
Uncertainty continues to challenge deals
Leroy Ball, president and CEO of Koppers Inc., says his company came into the pandemic highly levered, which put it at risk out of the gate.
“We saw a significant drop in our stock price because of the worry and concern over whether we’d be able to manage leverage through the crisis,” Ball says. “When you think about that on its face, that takes being able to use stock as a currency out of the equation for anything that you want to do. Certainly we had to be very hesitant early on, as well, until we could get an understanding of what the impacts would be on our business and whether we would have the ability and flexibility to move forward with any transaction.”
That position he says, made the company more open to potentially divesting some of the businesses that aren’t as close to the core. Koppers had already undertaken that process in the year prior, even preparing a virtual due diligence room. However, he says, there haven’t been a lot of suitors.
“Whether they were highly levered or not, they were being very hesitant early on and trying to understand what all this was going to mean to their cash flow and ability to do these sorts of things,” he says. “Everything kind of stopped there for a period of time until people got their legs under them again and were looking at possibly wading back into the markets.”
Nearing what appears to be the back end of the pandemic, Ball says he’s trying to understand the short-term impacts on any businesses Koppers is looking at, versus the potential long-term impacts. Nothing yet has moved far enough along to where substantive conversations are happening.
“Our eyes will be on trying to decipher short-term impact versus long-term. And that’s going to be a challenge, I think, for any company out in the space looking to add assets, wanting to make sure that what you’re buying is actually going to be there,” Ball says. “And there may be some things that structurally you look to do to help protect yourself. But again, you always deal with the other side that tends to avoid wanting to get into those sorts of structures.”
Less volume, better substance
Headwinds for some, tailwinds for others in uneven early-stage market
Michael Matesic says within Idea Foundry Inc.’s portfolio he saw tremendous success from some companies that were struggling before COVID, while others that were doing well pre-pandemic got wiped out. That led Matesic, president and CEO of the nonprofit economic development organization, to spend more time in the summer with existing companies discussing pivots — could they, how would they, or should they just hold tight and hope they could ride it out?
Venture capital firms, he says, saw existing portfolio companies suddenly running through cash quickly, which led to investors writing checks largely for their portfolio and not so much for new ventures.
In that way, startups in the earliest stages, Matesic says, continue to face headwinds, even as the market has adjusted to working within the constraints of the pandemic. Entrepreneurs pitching new ventures might get a virtual meaning with an investor, but it’s tough to land a first-time investment with brand new innovation as a brand new company with no reputation and no history.
Startups with funding and some market penetration, conversely, are in a much better position. For companies that are somewhat established, the system, as it’s geared now, is going to push them farther and faster.
However uneven and difficult the pandemic has been on early stage ventures, based on Matesic’s experience, some of Idea Foundry’s most successful companies started in the worst of times.
“There is a clarity that these challenges represent,” Matesic says. “You’re not going to do something as a hobby. You’re going to do it for real if you know that the resources are tough to attract and if it’s tough to be successful. The message there is those who choose to do it now are going to be more committed and execute better than those that started in the year preceding COVID. And that bodes well for all of us when it comes to that — less volume, better substance.”
Hard times require big changes for startups heading toward a new economy
As Sree Gadde, executive director at BlueTree Capital Group, sees it, there were two major shifts that occurred during the pandemic. The first, early on, was a pause in new investments and a shift to helping portfolio companies position themselves, understand what impact the pandemic could have on them, figure out their capital needs and then think through what could happen as the pandemic progressed.
The second shift, later in the year, was to look at what the world is going to look post-pandemic. Gadde says many companies discovered it was going to take a huge change to their business model in order to survive in the new economy.
“We’ve started to see some strong investment potential, where we see companies have changed their business model and said, ‘OK, people are going to be working from home more often, this is how it affects our industry. People are going to be traveling less on roads, this is what it does to us,’” says Gadde. “All of these different things, every industry just had this major shift, which has actually been great because it opened up opportunities for newer companies to really take on incumbents in any given market. But it has required all of our companies to start to think about what the new world looks like post 2021, 2022, and how we fit in there.”
Entrepreneurs who got a tighter control on expenses and revenue — and re-envisioned who and what they are and where they are going — were able to raise new rounds at higher valuations in the second half of 2020 and into 2021 because they were much better positioned to move forward into the new economy.
The year also saw a major shift in investment philosophy, with a move away from absolute growth at all costs as the incentive and into being fiscally conservative. There’s still a need to realize growth, but investors want to see companies become cash-flow positive, build up custom bases and build up pricing models that actually make sense.
Companies that were able to do that and organically grow before attempting to raise more money saw much more investor interest because they were in a strong position with limited downside risks, Gadde says. But those that were still attempting to grow at all costs have had trouble raising any money because there is too much uncertainty that they’ll be able to survive long enough to prove out the concept.
COVID-19 brings focus inward for fund-seeking startup
Fifth Season was headed out to market to raise large rounds that could put fuel behind the company’s growth when COVID-19 hit. That created a lot of uncertainty, so Fifth Season decided to do a bridge round with mostly insiders.
CEO and co-founder Austin Webb says the indoor farming company was still opportunistic and added on advisory but chose to use 2020 to focus on its farm in Braddock and then continue to expand. The first priority was to survive, and then thrive.
“It’s an important order of operations in a crisis like that when an unprecedented pandemic hits for the first time in a hundred years,” Webb says. “And so that’s what we were focused on.”
Meanwhile, demand for the company’s product increased. He says COVID accelerated two beneficial behaviors. Those were the number of online click and collect, and delivery demand. Fifth Season adapted to the increase in demand and launched its salads faster than it was originally anticipating, pulling that timeline up as more consumers turned to digital and delivery to get food.
Heading into 2021, Fifth Season is expanding quickly and has already identified the sites of its next facilities.
“It’s keeping the foot on the gas pedal for us for 2021, which will have its own challenges,” Webb says. “And of course, we’re all looking forward to the light at the end of the tunnel in terms of the pandemic. We don’t know when the light at the end of the tunnel is, as we think about production and distribution of the vaccine, but we know it’s coming. So there’s a lot of hope for all of us in general, but certainly at Fifth Season, a lot of excitement and hope around what’s to come for all of our folks here.” ●