The pandemic has impacted us all, forcing us to change the way we live and work. However, the innovations of businesses worldwide, and their ability to adapt to the coronavirus has been incredible. As a leading financial consulting firm that works tirelessly to streamline fast-growth, PE-backed companies, we’re continually innovating to provide you with data, insights, and best practices so you too can continue to succeed.
Today, we bring to you some of the newest growth equity market insights due to the pandemic. We recently asked a sampling of private equity and investment banking firms five questions to assess how COVID-19 has affected transactions and their firms’ experiences over the last few months. It is no surprise that each perspective is unique and heavily dependent on both the PE firm and portfolio company’s industry focus. Still, each practice offers something of value that you may be able to leverage. Below are highlights from those conversations.
When COVID-19 first hit, most firms expected transaction activity would pick up again in the September-October timeframe. Do you still hold that view?
Focus Strategies is an Austin, TX-based investment banking firm with over $7 billion in transactions under its belt across multiple industries. They shared that the firm’s mix of transaction activity has changed, “typically, our client roster consists of around 90% sell-side processes at any one time. This change has receded to around 50% sell-side, with the rest being mostly buy-side engagements. We expect this make-up to be entirely different 90 days from now, with many firms exhausting their PPP funding and working to raise additional capital.”
Additionally, Focus Strategies is “already seeing increased transaction activity which began to pick up in the July timeframe. We expect increased sell-side activity through yearend, but more prominently believe capital raising will be a significant portion of Focus Strategies’ mandate make-up.”
With offices based in Raleigh, NC, and Dallas, TX, Hargett Hunter invests and works across the US. The firm’s focus is hospitality industry investments, restaurant concepts with an average of six restaurants or less, making their restaurants feel more “local” than other larger concepts. While some in their portfolio are looking for capital, others are looking to ride out the pandemic’s effects. The firm has seen a decline in sales across its concepts, heavily influenced by geography and service mode. For example, those concepts classified as fast and fast-casual have experienced less of a decline. Although the same store sales for 2019 will not likely be achieved in 2020, many of the restaurants in its portfolio have bounced back quicker than industry peers. The firm also believes that contraction in the independent restaurant space may positively impact the firm’s overall portfolio of restaurants.
One unnamed private equity investor with over $6 billion in investments in growth-oriented middle-market companies shared that “they know that they don’t know,” and there is “realism and humility” in what they do not know about the pandemic. An argument could be made that there will be an influx in founder-led deals by the end of the year due to uncertainty surrounding the US Presidential election and potential changes in tax laws that could result. The firm shared that investment bankers they have spoken with believe there will be an increased number of stalled deals due to COVID-19.
With offices in New York and Los Angeles and a current investor in Bridgepoint Consulting, Odyssey Investment Partners has raised over $8.2 billion of private equity capital and is focused on middle-market company investments. The firm shared that they experienced a slight decline in activity due to COVID-19 and, like Focus Strategies, has seen an uptick in activity since July. The firm noted that the debt financing market has yet to return. As a result, the firm sees deals that have less leverage and more equity as valuations remain robust overall.
Do you believe that there will be decreased valuations and thus opportunities to be aggressive with acquisitions, or that there will be fewer opportunities due to reduced valuations? (e.g., sellers less willing to sell as values are down)
Focus Strategies: “Focus Strategies is holding firm on the belief that closely-held businesses led by aging owners will continue to seek exits. Many owners have been through three, if not four, economic downturns thus far and will look to capitalize on their hard work despite current headwinds.”
“It is also worth noting that we have experienced a notable increase in buy-side services. Companies that have managed their cash position well during the last six months are looking to take advantage of buying opportunities in the market (particularly larger strategic firms). We anticipate this trend to continue as companies exhaust their PPP funding and are forced to make difficult decisions about their path forward in an altered economy.”
“We also see earn-out provisions to help bridge the pricing gap from lower valuations due to reduced cash flows. The earn-out terms’ structure is varied based upon adjustments to purchase price, seller notes, or equity percentage ownership.”
“We are seeing a significant market bifurcation in which certain industries are widely affected by the fallout of COVID-19, whereas other industries have seen little effect or even experienced a boon in their businesses.”
Hargett Hunter: In the restaurant hospitality vertical, there has not been a platinum brand come to market since COVID-19. As a result, the firm is uncertain how COVID-19 will affect valuations and is not ready to conclude there will be a higher valuation for a “unicorn.” Some brands that were hot and high-valued are now bankrupt. Jeff Brock, Founder and Managing Partner, mentioned they are waiting to see the impact of the decrease in independents and if contraction in store base will positively impact stronger concepts.
Unnamed PE Firm: While once expecting a decrease in valuations due to COVID-19 and a restrictive financing environment, this firm has seen premiums in the purchase price for some deals due to scarcity of supply of high-quality assets.
Odyssey: Odyssey shared that a company may get a pre-COVID valuation if they are resilient and have continued to perform well. While some were forced to sell in May, those with less resilient models choose not to sell.
Do you believe there may be an increase in carve-outs as large organizations try to shed underperforming lines of business?
Regarding carve-out activity, the firms we spoke to were evenly split regarding the volume of carve-outs seen. Focus Strategies has seen an increase in carve-out activity over the last six months as “healthy firms are taking the opportunity to reassess their long-term strategies and divest of lines which are not complementary to their core businesses.”
Odyssey has seen more carve-outs by larger organizations, and these carve-outs are a larger percentage of the firm’s current deal flow. Like Focus Strategies, Odyssey similarly commented that companies want to focus on their core businesses in periods of uncertainty, so it is common for them to see the number of divestitures increase.
Conversely, due to Hargett Hunter’s focus on the restaurant hospitality industry, the firm does not expect any brands to be spun out. The other unnamed PE firm has also not seen an increase in carve-out activity during this period.
If you knew what you know now back in March, what would you have done more of, less of, the same?
Focus Strategies shared, “If we had known how long M&A activities would have been put on hold, we would have liked to spend more of the downtime focusing on building additional relationships with companies that fit our service criteria.” They continued, “Peaks and troughs are a part of any business. We were nimble to adjust to the current circumstances and look forward to serving middle-market business owners for their capital needs. Very few M&A professionals, including us at Focus Strategies, expected transactions to turn off so immediately, like flipping a light switch.”
Hargett Hunter: Sam Kaufman of Hargett Hunter’s Operating Services Team shared that the firm would communicate more and communicate faster, making sure there was a “greater flow of information up and down the chain,” from investors down to the employee level. Also, they would have had a plan to pause operations across their brands put together sooner.
The unnamed PE firm commented that the COVID-19 story has not yet been entirely written; they like the conservative approach they have taken, including the deployment of less capital.
Odyssey shared that the firm would not change anything, and although there is still a great deal of uncertainty, the firm is actively looking at platform acquisitions and add-ons that fit well with its investment plan and long term approach. “Valuation and flexible capital structure are key considerations in the environment,” Odyssey shared.
Are you looking more for add-on acquisitions to existing holdings or new acquisitions?
The mix of add-on versus new acquisitions has not changed much due to COVID-19 – there is plenty of capital to invest, and firms continue to be opportunistic, albeit intentional. Focus Strategies commented that “from an investment banking perspective, we are seeing mixed interest—some PEs are particularly focused on add-ons for existing holdings, whereas others are hungry for new platforms. This interest has not shifted because of COVID-19.”
Hargett Hunter indicated the firm is continuing to look at new acquisitions every day and is already seeing changes in plans and models due to COVID-19. Beginning in 2015, there has been a shift in more money spent on food outside the home compared to inside the home, and they do not expect this trend to change. The firm mentioned its commitment to helping great teams and brands manage through the pandemic.
The unnamed PE firm expressed a willingness to make add-on acquisitions, particularly when they have already met the management team.
As we continue to look past the pandemic and into the future, we feel strongly that the US economy is poised for a substantial rebound. After our conversations with PE firms, we’ve learned that there is a significant amount of capital standing by to invest as the economy begins to turn around. The competition for investments hasn’t diminished, and there are still multiple bids throughout the market.
We recommend focusing on organizations where the business model’s optimization and processes will provide significant value. Those companies that can increase sales, streamline operations and those looking to acquire similar businesses will be your most valuable investments.
Your success will be found by demonstrating your company’s ability to weather the pandemic and effectively scale the business. This resilience and discipline will showcase significant value to PE firms looking to invest. The deals are still coming, and they’re coming in strong for those that have been able to navigate the pandemic.
At Bridgepoint Consulting, we help companies like yours maximize your ROI through innovative financial technologies and automation to optimize and streamline operations. As a thought leader in the growth equity market, we’re continually bringing you the industry’s latest insights and trends. Stay tuned for our next piece by following us on LinkedIn or signing up for our newsletter. If you have questions or comments, contact us today.