Impact of COVID on Lower Middle Market M&A

As we approach the end of 2020, the mergers and acquisitions market has started to pick up steadily, after a dramatic drop in late Spring and Summer.

The number of deals under $100M  that closed in the third quarter was down by just 12% compared to the third quarter last year and there is solid momentum in the fourth quarter. However, total dollar amount of deals completed is still significantly lower than 2019, indicating smaller average deal size.

Companies and industries that have fared well or held their own during COVID, including consumer products and technology, are generally seeing the strongest rebounds in M&A.

Private equity looking for add-on deals. Private equity buyers are looking to put their money to work, and are in particular looking for “add-ons,” or smaller companies that can be folded into an existing portfolio company. In 2020, private equity buyers were responsible for 35% of business acquisitions in North America, and add-on transactions made up 73% of all private equity deals. With add-on transactions, private equity buyers are able to minimize risk by investing in industries they already know, and enhance profitability by leveraging synergies with their existing portfolio companies.

Strategic acquirers also active. Many strategic buyers are seeing 2020 and 2021 as a time to make acquisitions, designed to further diversify their own businesses, broaden their customer base, fill holes in their distribution channel mix or product mix, or add experienced personnel or key technology.

Financing available on a case-by-case basis. From SBA lenders to mezzanine finance, lenders are open to financing transactions on a case-by-case basis, assuming that both the acquiring business and target business can show resilience in the face of COVID. Interest rates are at rock-bottom, and SBA lenders are competing aggressively to provide financing for deals where the buyer and seller are both performing well.

Venture capital funding deal size up, number of transactions down. Venture capital companies have continued to invest throughout the pandemic. Interestingly, the overall dollar amount of VC capital invested in 3Q 2020 was even greater than in 3Q 2019, but the number of VC transactions fell. This means that each VC raise was larger, indicating some investors are gravitating towards less risky later-stage investments, vs. early start-ups.

Buyer focus on growth, and profitability. In general, companies that have experienced growth in 2020 as a result of trends that will continue post-pandemic (such as a move to online retail, remote work arrangements, focus on health and wellness, greater emphasis on the home, etc.,) will be attractive to acquirers. Buyers are also increasingly focused on key profitability metrics, including gross and net margin, and less inclined to consider marginally profitable or unprofitable companies. Companies that were profitable prior to COVID but which have had a challenging or unprofitable year this year may also find buyers, assuming there is a solid reason to believe the company will bounce back once the pandemic is over.

What should you do now if you are considering an exit now or in the future? It’s encouraging to see M&A activity picking back up. But as always – the best way to ensure a successful sale is to prepare well; to fully understand your options, personal goals and priorities; and to execute a professional sales process targeting qualified buyers who see strategic value in your company.

If you would like to discuss, please contact us. We are happy to address specific issues that may impact your business, answer any questions, and discuss timing and the current changing market. We have helped many entrepreneurs navigate the process to plan for and execute an exit. You can set up a confidential, no-cost consultation here.

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