I’ve decided to open up new Spend Matters Nexus columns and research briefs for everyone, not just subscribers, in the next few weeks, as we’re all certainly in a crisis period with the COVID-19 outbreak. To help make my coverage of investing and M&A more digestible, these dispatches will be shorter than usual (some will include frameworks and charts, others will not).
Having worked through two major shocks and downturns — the B2B.com implosion in 2001-02, the 2008-09 recession — I’m seeing both similarities and differences between those times and the coronavirus fallout today in the procurement, finance and supply chain technology worlds. But for different types of investing, asset classes and M&A activities, it’s clear the effects are already quite individualized.
Today, I’ll start with a summary perspective on what entrepreneurs, CEOs and business owners should expect for the next few months, based on transaction type. Please note: This column is not based on extensive primary research and survey data, but rather anecdotal evidence from what I’m seeing in the market, primarily as an advisor to sponsors and executive teams, but also as an angel investor and start-up advisor myself, outside of work.
The General Climate
It is important to keep in mind the general climate and enthusiasm for procurement and related deals has not changed. In fact, based on dozens of conversations with clients, colleagues and friends investing in diverse asset classes touching on procurement technology, it’s definitely as high as prior to COVID-19. The challenge, however, is getting deals, of any sort, done.
There are both demand (i.e., those raising money) and supply (i.e., those investing money) driven considerations and questions here.
On the demand (provider/vendor) side, here are a few:
- How will you forecast effectively? Sales and growth forecasting is more challenging than ever as of late March 2020, including whether specific customer segments will be partially or fully frozen for a period of time (or not); which raises the next question …
- … How will funds be used? For example, if a major purpose of a raise is to invest in top-line growth, and if your primary sales model requires on-site meetings (sales, sales engineering, etc.) and/or the purchase of your capabilities is considered non-essential until the crisis is over, how will you use the funds?
- In terms of recapitalization and exits, will investors and management be willing to take a substantial haircut in the current environment, even though metrics up until calendar Q1 2020 may not suggest a “down-round” type of situation? Will they be willing to accept more onerous deal terms? Note, this last point is also as important on the capital raise side as well (especially important, in fact).
- How will you manage cash — for both survival and growth? Many CEOs in this sector have lived through downturns, but the management of cash in today’s coronavirus environment is especially complex. An airline we know of told one of its suppliers it did not plan to pay its vendor bills until next year. This is unprecedented territory for CEOs, CFOs and boards. How will situations like this impact your ability to manage your business, and subsequently, seek and deploy outside capital to continue to fund operations, let alone fund growth? Just because it’s “on the the balance sheet” as a receivable, does not mean you will receive it within a normal window, which makes forecasting how you will use invested capital even more difficult.
- If applicable, will you be willing to enforce, accept and/or submit to a material adverse change (MAC) or material adverse effect (MAE) clause with the counterparty?
On the supply (investment/buyout/corporate development) side, there are different, yet sometimes related, considerations:
- Are certain targets adversely impacted more so than others based on their primary business (e.g., T&E providers)? Is this an opportunity/arbitrage play now or something to just put on pause given the risk?
- How much credit risk exists in the target’s customer base? Is there concentration or concern in regard to hospitality, airlines, aerospace, automotive or other industries likely to be negatively impacted in the near-term. Conversely, are there industries in which increased demand is likely to outplace current working capital availability?
- As a sponsor, how will you meet and work with management throughout the analysis and diligence process? This is especially important in all change-of-control acquisitions, in which significant diligence is conducted (as well as larger, minority growth capital / private equity investments), and perhaps less so (but historically still important) in angel, seed and venture deals.
- How will your partners (consultants, legal, auditors, etc.) do their work when many have required at least partial (if not more) on-site work in the past?
- Especially in the case of venture capital, do you risk permanently damaging the potential relationship with an attractive target by proposing deal terms that deviate materially from what would have been proposed just weeks ago? Or by dragging your feet?
- In the case of leveraged transactions, will lenders lend for a particular deal given the circumstances? What will their terms be? What will debt-to-equity ratios look like compared to the norm?
- Will underwriters/insurance providers have any additional requirements and diligence questions (if applicable)?
- How will post-merger/post-acquisition integration work in a virtual environment? (This is uncharted territory.)
- Will challenges within a current portfolio take away from the time to research and pursue new opportunities?
- For angel/seed investors, what is the willingness to part with cash given overall portfolio declines and related considerations?
What’s on My Mind
As this series continues, I’ll attempt to flesh out many of the themes above for different groups, with an emphasis first on private-equity and corporate development-led transactions. I’ll provide key takeaways and recommendations, including how we’re adapting our strategy and due diligence capabilities for the current environment.
But here are a few parting questions that are keeping me up at night during the COVID-19 crisis:
- How do we do what we do without meeting people face-to-face?
- What start-ups and venture-backed companies will not be able to manage a slowdown given where they are in their funding cycle and cash flow needs?
- Will corporate development leaders be able to fully press their advantages over financial buyers? Do they have the bandwidth to scale up quickly enough to take advantage of arbitrage opportunities that did not exist previously?
- When will sponsor-led deals that are currently on ice — either during or before a process was expected to start — come unstuck?
- What clever tuck-in opportunities will companies have if they are willing to shoulder potential near-term risk?
- Will public sector-centric deals command a premium compared with the past given stimulus spending on the upswing — i.e., the “insulating” factor?
- For both buyers and sellers, how have you adjusted your transaction checklist (preparation, diligence, etc.) to account for COVID-19 considerations?
Please feel free to post a comment or ping me directly via LinkedIn with questions or ideas. In the spirit of open-sourcing this content, it would be great to add other voices to it.
Jason Busch is Managing Partner of Azul Partners’ Investor Advisory Group. He works with sponsors, CEOs and boards on data-driven due diligence, M&A and strategy. Jason is also the lead author of Spend Matters Nexus, a private newsletter and subscription service. Spend Matters and Spend Matters Nexus are owned by Azul Partners. His investment disclosures and other activities can be found on LinkedIn.
