by Fritz Battcher
The COVID-19 pandemic disrupted many aspects of business in Nevada, including buying and selling companies. In the second quarter of 2020, deal activity in the U.S. dropped by over 40% from an already record low first quarter of 2020 caused mainly by the uncertainties of COVID. In Nevada, the trend was similar to that of the U.S. When COVID shut down a large part of the economy in March 2020, many deals already underway were abandoned altogether or put on hold.
After an initial overall drop in deal activity, there are currently signs of an uptick. Independent, family-owned companies that have fared well during COVID have been the most targeted for acquisition by strategic buyers looking to add on to their business prospects. While there are positive signs of increased deal transactions, COVID has changed the way those deals are being done.
Doing deals in this current environment presents some unique challenges. One of the biggest negotiation points in any deal is the valuation of the company being bought. COVID has created uncertainty and disruptions to many businesses that makes the valuation of those businesses more difficult. Companies need to make sure they analyze their financial statements and have a great understanding of how the pandemic affected their profits and losses, inventory levels, demand for product, and their supplier and distributor relationships.
A buyer will engage in due diligence to understand the operations of a company, but due to COVID, this analysis and process can take much longer and be more in depth. When valuation gaps emerge, buyers and sellers need to bridge that gap. The most typical way to do so is by negotiating contingent payments or consideration based on certain milestones (usually financial) being achieved by the selling company. This process, often called an “earnout,” can make deals more complicated and longer to close. Earnouts are very common in today’s market due to valuations being at odds more frequently due to COVID.
A new aspect to deals due to COVID are the stimulus programs enacted by the government. The Paycheck Protection Program (PPP) under the CARES Act created new loan procedures that didn’t exist before the pandemic. Many companies have PPP loans that will have to be addressed in the acquisition process. If PPP loans have not been forgiven, then the purchase documents will have to deal with these outstanding loans. The most common way that transactions are addressing PPP loans is through an escrow arrangement with the lending bank. The seller will place the amount of PPP loans received into an escrow account with the bank that made the loan. If the loans are forgiven, the bank releases the money back to seller. If the loans are not forgiven for any reason, the bank keeps the amount that was not forgiven. Because this escrow process introduces the bank as a party into your deal, it can create timing delays and more complications. When thinking about selling your company and if you have a PPP loan, advanced preparation and having a relationship with your bank can be helpful.
I believe deal flow will continue to increase in the U.S. and Nevada. Being prepared to do a deal is key to a more efficient acquisition process. Understanding that COVID will increase due diligence, create possible valuation gaps, and introduce new concepts — like PPP loans — into the transaction documents will give you an advantage in a successful deal.
Learn more about buying and selling companies during COVID at NCET’s virtual Biz Bite on April 28, 2021 from noon to 1 pm with virtual networking from 11:30 am until noon. NCET is a member-supported nonprofit organization that produces educational and networking events to help people explore business and technology. More info at https://ncet.org/ncet-biz-bite-buying-and-selling-company-during-covid/
Fritz Battcher is a partner specializing in corporate and business law at Holland & Hart in Reno. (www.hollandhart.com/reno)