Musings on the post-COVID deal market – What now?

May 2020 — By Carolyn Mathis

There was a time – only a few months ago, but it feels like an eternity – when the outlook for 2020 was bright.  The M&A market was dynamic, buoyed by a decade of economic expansion, accessible credit markets and years of robust Private Equity capital flows.  Then out of the blue, we were hit by an unexpected shock in the form of this global pandemic.  So far, the deals that have closed since March 15th were already well on their way to closing.  But what can we expect for future deals?  As we take stock of what’s next for middle market M&A, we break down the specific impacts that this crisis is having on the M&A market.


The most obvious impact is the direct financial hit that most businesses have experienced.  Depending on the end market, there has been a wide range of severity, with some industries virtually stopped, while a few have seen a surge in demand.  For most, however, business continues but disruptions to demand and/or the supply chain have taken a serious toll.

In the near term, deals with the path of least resistance: 

Strategic tuck-ins where relative size makes leverage less important and cost synergies can offset a valuation gap.  

With so much uncertainty about the future progression of the health crisis, timeframes for lifting social distancing restrictions and potential future disruption from additional waves of the virus, 2020 forecasts are very much up in the air.  Unless your business is in the minority of industries that have been unscathed, fundamentals alone make this a challenging time to sell a business.

Capital Structure

During the great recession, leverage multiples dropped from 6x in 2006 to 3.5x in 2009.   In the economic expansion that followed, debt levels recovered and have been hovering once again near 6x for several years.  For the time being, that is sure to change as capital structures become more conservative in this uncertain environment, directly impacting valuations.  That might be short-lived, however, with so much liquidity coming from government stimulus.  Once we gain clarity on future earnings progression, we are likely to see capital structures return to previous levels.  

Risk Tolerance

Lenders are unlikely to be the only ones to shy away from risk amidst uncertainty.  Expect near-term assumptions about future growth and exit multiples to decline, negatively impacting the size of the equity check they are willing to write. 

The Bottom Line

Right now the hit to earnings, an uncertain outlook and more conservative lending expectations combine to create a valuation gap for many sellers who anticipated transacting in 2020.  Also impacting deal activity, COVID-related travel restrictions create logistical impediments to building the foundation of a trusted relationship that is a critical element of a successful deal. Not surprisingly, most market participants expect deal activity to be muted for the balance of 2020.  That being said, some situations warrant an easier journey to the closing table.  In the near term, deals with the path of least resistance will be strategic tuck-in acquisitions of companies whose markets and business models are sheltered from the COVID impact, where relative size makes leverage less important and where cost synergies can offset a valuation gap.

Once the public health crisis subsides and the economy can get back to work, we expect a strong recovery in deal activity. But we believe it will be a tale of two markets.  

Looking ahead

There is a lot of cash on the sidelines - in 2019 private equity funds raised a record $300 billion in capital.  In addition, government stimulus efforts have pumped a lot of liquidity into the system.  So there is good reason to believe that once the public health crisis subsides and the economy can get back to work, we should see a strong recovery in deal activity.  But we believe it will be a tale of two markets.  We expect to see low interest rates for the foreseeable future and a premium placed on growth.  This environment has brought rapid change to many sectors of the economy, creating a bifurcation between the winners and losers.  Trends that were already underway have been dramatically accelerated.  Enabling technologies that facilitate efficiency and the ability to communicate and engage remotely will see strong capital flows.  

For well-positioned companies in software and tech-enabled services, we believe that a subdued 2020 will be followed by a wave of opportunity in 2021 and beyond.  

We knew that the long expansion would come to an end at some point, bringing recession in its wake.  Now that the recession is upon us, it’s time to look ahead to a recovery with a technology adoption curve whose compressed timeframe will exceed any of the forecasts from the pre-COVID era.