The COVID reset of the M&A market

The private equity industry adapted, like everyone else did in 2020, in order to survive. But unlike many others, adaptation is the private equity industry’s core competency.
People drawn to the private equity industry are hyper-competitive and kick into overdrive when they feel there is an opportunity or a threat. COVID-laden 2020 presented both. The ability to adapt has served the industry well for decades and is, in part, reflected in investment returns that have historically exceeded returns available in the public equity stock market, even after taking into account its illiquidity.
In the August 2020 edition of Smart Business, I wrote, “By the time you read this, much of what I write about will be more clear, and my viewpoints could be proven wrong.” I observed in that article that investors like predictability, and that negative shocks to the economy like a recession are not all bad because they reveal the truly exceptional businesses in which to invest. However negative shocks due to a pandemic were different because the tried-and-true guideposts that guided everyone through past negative shocks were not reliable indicators.
As I guessed, there was more activity than many people expected, given restrictions on travel and the general economic turmoil. I pointed to the fact that banks appeared to be functioning normally and quickly facilitated financial relief through the SBA’s PPP program — which specifically excluded private equity funds and indirectly excluded their portfolio companies through “affiliation” rules — and that private funds had over $1 trillion of committed capital waiting for investments.
Evolution, as an example, was able to acquire two “platform” companies and made four additional add-on acquisitions. Neither of the platform companies came to market because they were troubled as a result of the pandemic, but rather were exposed as exceptional opportunities because they withstood the pandemic.
The four add-ons were not troubled, either, but the owners’ retirement plans were accelerated by the additional challenges the pandemic created and the negative financial impact that resulted. Using Evolution as a micro example of the broader private equity market, the balance of 2020 played out as I expected. One thing that surprised me, though, was that most of the opportunities that been negatively impacted by the pandemic — but not permanently so — did not get any “COVID adjustment” to normalize earnings from an extraordinary event. Acquisitions were valued as they always were, based on trailing 12 months earnings with adjustments, but not COVID adjustments. If anything, there were offsets by the fact that travel, entertainment and parking expenses were near zero.
I do see one permanent change to the private equity industry — and every industry — and that is remote working. We realized very quickly that we were minimally impacted in the short term by remote work and only moderately so over the long term. The use of video conferencing exceeds use for regular phone calls now. Everyone knows what wall coverings others have in their homes, what books they read and the names of colleagues’ children.

Those glimpses will hopefully develop into more meaningful working relationships. Previously, one-third of my travel was routine check-ins or board meetings that can easily be handled by video conferencing. Not traveling saves both time and a tremendous amount of money typically allocated to meals, hotels, plane tickets and Uber rides. While everyone was glad to see 2020 end, we all adapted, either temporarily or permanently in our own way, and we will all be stronger for it.

Jeffrey Kadlic is a founding partner at Evolution Capital Partners