Excerpted in part from the July issue of the INSIDE Public Accounting Newsletter. Subscribe TODAY!
By most accounts, 2020 was shaping up to be a banner year for M&A during the year’s opening months, continuing a trend that had been well established in the profession over the previous few years.
Then came a global pandemic and recession and a new world of remote work.
So, where do things stand now as the economy begins to reopen in fits and starts, firms have started to adjust to a ‘new normal’ and the economic toll of the crisis is growing by the day? INSIDE Public Accounting (IPA) reached out to three veteran players in the profession’s M&A space to get their takes on what has changed and what it all means for getting deals done in a rapidly shifting environment.
The Outlook for 2020, Pre- and Post-Pandemic: While nobody can say for certain how the year would have played out without the disruption of COVID-19, it was certainly looking like an active, robust M&A market before things started getting dicey in early to mid-March. Russell Shapiro, an attorney for Levenfeld Pearlstein in Chicago, says the shutdown affected different negotiations in different ways, generally depending on where they were in the process when the pandemic hit.
“Some transactions that were already in the works managed to close, some were terminated but most are still in some state of discussion or process – they’re just postponed for the time being,” he says. “There’s just a lot of uncertainty right now, and nobody really knows what things are going to look like when the dust settles.”
Even so, Joel Sinkin, president of Transition Advisors, thinks the market may pick up sooner than expected. That’s because of a phenomenon that also unfolded coming out of the economic downturn in 2008 – firms going on the hunt for an acquisition because their organic growth had stalled. One of the main stumbling blocks going forward, however, will be the inability of prospective partners to meet in person – something that still makes a difference, even in these days of tech-enabled remote work.
“It’s hard to close a deal through Zoom,” Sinkin says. “Deals that started before the pandemic are still closing or at least proceeding toward closing, but many are now hitting a roadblock where there’s not much more they can do without getting face to face. You can do due diligence and a lot of other things virtually, but it’s hard to get to the comfort level you need in this kind of deal without that in-person contact.”
Shapiro adds, “Because so many of these deals are true mergers with partners coming together from two different firms, everyone wants to see if there’s a cultural fit.” Shapiro notes that firms that already know each other will have an easier time moving ahead with a deal right now. “So, the question of due diligence during this pandemic has less to do with the books and records – most of which was being done electronically prior to this anyway – and more to do with the cultural element of the deal, and that’s why a lot of potential deals are on hold. How do you get a comfort level with someone you’ve never met? It’s not like you’re just selling a machine – you’re going to be partners with these people. And there’s a human element that’s hard to replicate online.”
If this hurdle can be cleared as offices start to reopen and life gets back to some degree of normal, both Shapiro and Sinkin believe that 2020 can still be partially salvaged. The real action, however, is likely to heat up in 2021.
“Assuming things have calmed down, 2021 could be a huge year for M&A,” Sinkin says. “It will be more than just the pent-up demand, though – for firms that have lost a lot of business because of the impact of the pandemic on certain industries, the quickest and maybe only viable way for them to get that back and start growing again will be to make a deal.”
The Impact on Deals Going Forward: Which, if any, of the fundamental elements of a merger or acquisition stand to be significantly disrupted by the pandemic and/or the still-unfolding economic recession?
“Due diligence will take on an entire new meaning,” says Carl George of Carl George Advisory in Indianapolis. “Firms will be diving deep to try and find any cracks in the foundation.”
Among the areas prospective buyers will be scrutinizing more closely, George believes, are things like client sustainability and client profitability. In addition, buyers will be looking for greater assurance of financial viability in target firms. How ‘clean’ is the seller’s balance sheet? Are there appropriate billing and collection protocols in place? Historically, how well have the owners run the business? Has the firm built in appropriate next-gen leadership and expertise?
Shapiro agrees that certain areas of due diligence will be inspected in microscopic detail in the months and quarters to come.
“I think firms are going to think a lot more about how clients are going to be impacted by the recession,” he says. “Unlike most recessions, where every industry is more or less affected in the same way, this is going to affect some industries much more than others. People are going to have to really understand the industries that the target firm services, and really understand the ability of those clients to survive.”
Meanwhile, with so many employees working remotely and firms considering downsizing their expensive physical spaces, Sinkin points to one hidden area of potential deals that may take on sudden new significance in the wake of the pandemic and recession.
“Leases may turn out to be the biggest albatross for quality practices that would normally have great demand,” he explains. “These days, nobody is going to want to take on a five-year lease just to pick up $3 million in business.”
The Best Candidates Today: When the M&A market does get back to some semblance of normal, it’s likely that the same qualities that would have made for a viable target will remain so – specifically, a strong client base, up-and-coming leadership, solid financial footing and profitable niche penetration.
“Overall, I don’t think the attributes are going to change all that much,” Shapiro says. “An attractive firm before this is probably going to be an attractive firm coming out of it.”
Shapiro further notes that acquiring firms that were strong coming into the crisis and that seem to be weathering the storm pretty well will continue to absorb other firms, resulting in a buyer dynamic that looks very much as it did before the pandemic. On the seller side, he says a lot of firms will likely be looking to merge up, including some that have lost the will to fight through this type of disruption on their own.
“For some firms, this crisis highlighted the need for technology infrastructure they didn’t have – it’s not that they couldn’t survive, but they couldn’t thrive,” he says. “Technology was one of the elements really driving deals prior to this, and that’s been accelerated now.”
And while the pandemic is unlikely to reverse the longer-term trend of firms looking to move from compliance to consulting work, Sinkin says the experience of the past few months may cause acquiring firms to rethink the speed at which they plan to make that transition.
“The difference now for some firms is that there seems to be a stronger interest in picking up the kind of compliance and tax work that they were hesitant to do before,” he explains. “Everyone has been talking about AI and blockchain taking away a lot of that work, so it was hard to see firms like that as viable M&A candidates. But now some people have seen the attrition in their client base and are more interested in picking up that type of work again. Client accounting services and outsourcing have become bigger niches than they were before.”
COVID-19 may have inspired a brief pause on the seemingly inevitable move toward consulting, but once things start returning to normal, so too will that forward momentum – as will the M&A market as a whole.
“If there’s a recession but there’s health, you’ll see a very busy marketplace,” Sinkin says. “Most firms are losing 5% to 10% of their revenue, and the quickest way to make that up in many cases will be a merger.”
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