By Claire H. Chadwick, Valuation & Forensic Services Associate
COVID-19 Impact on 1st Quarter 2020 Transactions
Trends for Middle Market Deals
Through the first two-plus months of the 1st quarter of 2020, private business sellers continued to experience advantageous market conditions. Due to the coronavirus pandemic, a significant slowdown occurred in deal activity, beginning in early March. According to GF Data®, 89 deals were recorded in the 1st quarter of 2019, while 62 deals were recorded in the 1st quarter of 2020 (from their pools of over 200 financial sponsors.) Moreover, many transaction advisors have noted that deals have stalled or are treading water with a “wait and see” approach.
One of the most common valuation multiples is TEV/EBITDA. TEV is an acronym for total enterprise value. EBITDA is an acronym for earnings before interest, taxes, depreciation, and amortization, and is also a proxy for operating cash flow.
Transaction activity and related deal multiples can vary greatly depending on the size of the business, economic conditions, industry conditions, interest rates, and political factors (e.g., trade tariffs). To gauge the state of the M&A markets, GF Data® provides transaction statistics on private equity-sponsored M&A transactions with deal values ranging from $10 to $250 million. A summary of TEV/EBITDA multiples by transaction size is detailed in the table below. 
Total Enterprise Value (TEV)/EBITDA
|TEV (in Millions)||2003-2015||2016||2017||2018||2019||YTD 2020|
Deal Activity (Immediately Before the Pandemic)
As is indicated in the table above, EBITDA multiples ranged from 5.7x to 9.6x in the first quarter of 2020, with an average multiple of 7.4x for the current YTD period. The average multiple was slightly higher than the previous quarter’s average of 7.1x. GF Data notes that closed deals replicate “quiescent conditions” that have persisted since 2017.
GF Data also notes several thought-provoking points about the relationship between the size of businesses and pricing. As noted in the table above, EBITDA multiples tend to increase based on size of the target company. Further, with respect to buyouts, larger businesses frequently reap rewards in the form of premiums for their superior financial characteristics, established management solution post-sale, and institutional rather than individual or family ownership prior to the sale. Fascinatingly, every bracket size offering all three of these features received premiums in market (prior to the onset of COVID). GF Data also notes that in the past, smaller businesses have usually encountered penalties for their size and below par financial characteristics.
With respect to debt, overall levels have remained relatively steady. The 1st quarter of 2020 saw an increase in average senior debt multiples from 3.0x in 2018, to 3.3x in 2019, and to 3.5x in 2020. GF Data notes that this steady increase in senior debt multiples depicts that senior debt providers are feeling the pressure to contend with unitranche debt, a hybrid debt structure combining senior and subordinated debt.
COVID-19 Impact on Transactions
For further information related to COVID-19 observations on transactions, we recommend reading GF Data’s recent commentary “Who Are You?” by Andy Greenberg, the CEO of GF Data and of Greenberg Variations Capital.
Trends for Smaller Deals
Prior to the pandemic, smaller deals (transaction values below $10 million) experienced a rebound this quarter, with average selling price/EBITDA multiples averaging 4.8x. This first-quarter increase in 2020 (primarily consisting of deals in January and February) experienced the highest transaction multiples to begin a year across a six-year time frame.  However, as compared to larger deals, transaction multiples for smaller deals tend to be more volatile as the landscape of buyers are significantly different as compared to larger financial buyers such as private equity firms.
Keiter Observations and Comments on Transactions in Recent Months
- Strategic buyers are continuing to execute synergistic acquisitions generally on terms that were negotiated prior to the onset of COVID, provided that the target company has not experienced significant declines in operating results and earnings visibility. Active strategic buyers tend to have stronger balance sheets and longer-term holding periods for acquisitions because of potential operating synergies, whereas private-equity firms purchasing platform companies may be taking a shorter-term view.
- Performance in public markets has rebounded in recent weeks (although still volatile), and this tends to follow through into private market transactions. Based on our observations, recent trends seem to suggest a decline in multiples of about a 1x turn of EBITBA as compared to the data reported above, which was based upon transaction results prior to COVID.
- With respect to debt financing, banks are experiencing compression in interest rate margins, and therefore, are starting to implement LIBOR floors of 1% as well as increasing spreads over LIBOR in order to improve net interest margins. Furthermore, access to senior debt based on a target company’s cash flow is uncertain in this environment, and banks are increasing their loan loss reserves and we believe will be closely reviewing collateral coverage requirements as we enter the third quarter of 2020. Consequently, the trends noted by GF Data in the first quarter might not be applicable in the current environment.
Proceed with Caution
The multiples noted in the charts above are based upon an average of several thousand transactions. Moreover, much of the recent data reported is based on transactions that occurred in January and February of 2020 (prior to the pandemic). Therefore, blindly applying these multiples to a particular business might not be appropriate. In addition, the current M&A markets are in uncharted territory. Private businesses are most likely focusing on short-term survival versus long-term strategy. As previously noted, any near-term deal activity will most likely be fueled by strategic buyers who will look to achieve synergies versus financial buyers purchasing a cashflow stream.
How can Keiter assist?
Keiter guides privately held businesses in analyzing and coordinating all aspects of the transaction so that the results are most favorable. By working with clients at an early stage, we are able to understand their business and help identify specific needs. We help sellers in maximizing value and assist acquirers in ensuring the acquisition is a good fit for their organization and the owner’s goals.
Maintaining the structure of a transition so that it is tax efficient is one of our top priorities. Our approach minimizes net cash outflows for a purchaser and maximizes net cash received by a seller after taxes. Through our relationships with investment bankers, lenders, and legal counsel, we are able to assist clients in developing the required team to complete successful mergers, acquisitions, and divestitures.
 GF Data M&A Report – May 2020. Conshohocken, PA: GF Data Resources LLC, 2020
 DealStats Value Index Digest – 2Q 2020. Portland, OR: Business Valuation Resources, LLC, 2020
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.