After humming along quite happily with a high level of confidence into early 2020, Iowa’s mergers and acquisitions market briefly went into shutdown mode this spring with the arrival of the COVID-19 pandemic. Buyers and sellers alike scrambled to wrap up transactions from the first and second quarters and pulled the shutters on a number of other deals in earlier stages.

More than six months into the pandemic and with still a potentially long road ahead to economic normalcy, the Business Record interviewed several professionals who advise companies on both the selling and buying sides of transactions to gauge the effect on deal flow, and what sort of strategic adjustments are being made. 

The four M&A experts we spoke with in separate interviews each said that they expect the volume and dollar amount of transactions to be down significantly over the next 12 months, and that the types of deals have swung firmly into an opportunistic buyer’s market. 

Prior to COVID-19, M&A activity was strong in 2019 and into the first quarter of 2020, particularly in the lower/middle market [under $500 million of transaction value], said Tom Cavanagh, a shareholder with BCC Advisers in Des Moines who works primarily with M&A transactions. 

“It was down from a record 2018, but overall a very healthy year,” he said. “We were expecting the same or better for 2020. From all we were hearing, it should have been another strong if not a record year.” 

Year-to-date, 2020’s M&A activity has been about half its normal pace, but activity has begun to pick up in the past month, Cavanagh said. While July activity appeared to be on par with year-ago figures, that may just be a result of pent-up demand from earlier in the year, he said. 

“We’re seeing the quality of companies selling has improved,” he said. “You’ve still got the same number of buyers. Those who weathered the storm are in a position to engage.” 
Chris Sackett, a managing partner with the BrownWinick Law Firm, said it was definitely a seller’s market for mergers and acquisitions before the pandemic shutdown. 

“Certainty and confidence drives high multiples for sellers,” he said. At the same time, however, “Everybody had a sense that at some point the bull market had to come to an end. So diligence and closings were happening quickly.” 

With COVID “turning everything on its head,” the due diligence process has slowed to a crawl, as earnings numbers are viewed as unreliable due to the skewing from federal pandemic aid and reduced revenues, Sackett said. “So valuations are uncertain, and when that happens, we tend to have a buyer’s market.” 

Among the challenges for deals that are still moving forward are debates over travel — or deciding whether the diligence process can be conducted via videoconference. “I’m actually seeing personality profiles being requested,” he said, “because if I can’t sit across from you, I have to get some assessment of your character and reliability.” 

BCC’s Cavanagh noted that there are more videoconference meetings between sellers and buyers than ever before, which coupled with higher due diligence slows down the process. Those transactions that are moving forward are moving slower,” he said. “The consensus is that if [deals are] still alive now, they’re probably going to move ahead.”
 
At the same time, “there are certainly some companies that were thinking about selling in 2020 that now may be putting that on pause for one, three or five years,” Cavanagh said. “That certainly has an impact on owners and their succession plans.” 

Ready capital still searching for deals  

Although private equity firms largely hunkered down to address the needs of their existing portfolio companies during the initial months of the pandemic, they’re not going to be sitting on the sidelines very long, say local M&A experts.  

“Private equity funds are still looking for deals — there are still trillions of dollars in capital available [nationally],” said Adam Claypool, managing principal of Bridgepoint Investment Banking in Des Moines. “I think there is still an appetite for quality businesses, no matter what part of the business cycle you’re in,” he said. 

At the same, he noted: “I think folks are waiting for the other shoe to drop, honestly, that they’re waiting for the [state’s] revenue numbers to take another hit. Folks are very cautious about the economic outlook. [The government] has plowed billions into the economy; there is only so much the government can do.” 

Sackett said the dynamics are changing very quickly in favor of the buyer’s side. With that change comes some different strategies, among them more generous earnouts and holdbacks. 

“I’m seeing some combination of larger earnouts and holdbacks [by sellers], from 30% to 40% and as large as 50% earnouts,” he said. 

An earnout eliminates some uncertainty for the buyer by enabling the buyer to pay a portion of the sale price upfront with the remainder based on some measure of future performance. A holdback is a portion of the purchase price that is not paid at the closing date but held in a third-party escrow account until a certain condition is met. 

Sackett said private equity buyers are encouraging more rollover transactions in which some of the proceeds are rolled into the fund as an equity stake. “Now I’m seeing a little bit more of the opportunistic buyers kicking the tires now, seeking companies that might be opportunistic buys.” 

Hunkering down, seeking capital 

Iowa companies generally do pretty well in a crisis because of their tendency to manage their operations conservatively, Sackett said. “So they may have a better ability to hunker down in a situation like this,” he said. 

Nevertheless, the state’s higher reliance on the agriculture industry is putting some companies, particularly ag-related manufacturers, in a tough space right now, he said. “They’re being hit particularly hard. By and large, I would say most of those companies are well capitalized.” 

Sackett said Iowa banks are putting aside reserves pretty heavily because of anticipated loan defaults. “I’m actually hearing what I would call the right things from bankers on their intentions to hang with their good customers who are falling on tough times,” he said. 

Generally, the current environment may favor opportunistic buyers — and will also drive demand for additional capital. 

“Folks can tighten up their belt for a three- to six-month tough spot, but for a two- or three-year tough spot, that stress is starting to create opportunities for strategic buyers,” Sackett said. “For those companies that don’t want to sell, they’ll need to find sources of capital. We’re already seeing some of that funding emerge. And I hope it will come from local sources, rather than from out-of-state hedge funds.” 

JD Geneser, a senior partner with LWBJ in West Des Moines, agreed that deals are still occurring. The CPA and business advisory firm specializes in M&A transactions. 

“We actually sold a manufacturer during this COVID period,” he said. “I think some of the concerns there were due to [worries about] workforce. We did see some concessions on terms and pricing. We’ve also seen a lot of private equity funds that have probably taken a quarter off but are now back in the market.” 

Geneser said the upcoming presidential election and uncertainty about the future handling of capital gains has gotten more owners thinking about succession. “Sometimes business owners tend to put off the succession discussion,” he said. “I think this year has pushed some owners to consider taking an exit.” 

The last half-dozen deals his firm has done have been strategic moves by private equity funds doing “roll-up” mergers of competitors to gain market share, Geneser said. “I think we’re seeing a little bit of an uptick in private equity funds [that are buying]. They have a timeline where they need to deploy capital.” 

There is no doubt that M&A deals will continue to take place, he said. “It’s been an interesting time, though — there’s no question about that.”