Deal Making in 2020 - Lessons from the Road Less Traveled


Capstone Headwaters 2020 Road Trip

Written by Brendan Burke, Head of Sponsor Coverage

The Road Less Traveled

My Grandmother’s COVID test came back positive on April 21, 2020.  It took a month for the family to get clearance to visit, so I decided to road trip to see her[1]. A colleague reacted to my plan by asking if I was interested in meeting up in person along the way.  I paused because the only people that I had seen for months were my wife, son and sporadic Amazon[2] drivers.  It got me thinking about what an in-person meeting might look like amid a pandemic.  I accepted the offer but laid out strict ground rules consistent with government and medical guidelines[3]

As I ventured back into the world, I embarked on an I-95 tour from Washington DC to Boston.  In the past month, I have taken dozens of meetings in street corner cafes and smoothie shops, beneath Starbucks umbrellas, on beaches, on a stand-up paddleboard, on a fishing boat, on a bike and at a picnic table in a city park. It was wonderful and occasionally joyful to reconnect in person.  A few folks tried to hug me[4], a humble reminder that Zoom[5] is no panacea for loneliness. While less efficient in terms of route density than usual, the tour was one of the most memorable ‘business trips’ of my life. Along the road a few clear dealmaking themes emerged: 

Fewer deals & tighter processes

As you can see from our Q2 Capital Markets Update, middle market deal closings and launches were greatly diminished and deal volume fell more than 40% from Q1 and 22% year-over-year.   Further exacerbating this problem, investment banks are running very tight processes, only approaching Tier 1 buyers with strategic angles.  Sellers dip their toes in the water to see if healthy assets can still fetch pre-COVID multiples.  If they sense softness in demand, they pull the asset off the market quickly and quietly, avoiding the stigma of a failed process.  Until the credit markets thaw further, we expect these narrow sell-side processes to be the norm.

Creating Deal Flow

When the teasers for new deals stopped arriving in their mailboxes, the savvy business development professionals in private equity began campaigns to create their own deal flow.  Several firms have been particularly aggressive in shoring-up their pipeline for new opportunities, one setting a record for deals closed and assets deployed in the 2nd quarter. A few notable tactics: 

Front door closed - go through the backyard.  Back in March and April, private equity firms went into the capital market seeking to buy the debt of businesses that they bid on and lost in auction.  They bet on a swift recovery and they did not mind owning the asset if the company’s short-term prospects darkened as a result of the pandemic.  Given the rapid recovery in the bond market, the viability of that strategy was short-lived. 

Up and down the food chain. Large LBO firms are combing over the portfolios of smaller funds and making inquiries directly or through investment banking intermediaries.  The strategy is generally to offer a full price for A+ assets that have weathered the pandemic.  In this scenario, the big sponsors can deploy capital by piggybacking on the due diligence and institutionalization completed by the smaller fund. The smaller sponsor forsakes the hope of an extreme outlier bid that a full auction might yield, but locks in a strong multiple on invested capital to Limited Partners[6].

Stoking Embers.  Established sponsors are picking over their deal flow graveyards for busted deals and former prospects that never materialized.  Mark Gartner of ClearLight Partners writes, “[I’ve been] reaching back out to old prospects that were not previously ready to transact but might be now in light of COVID.”  Sponsors have been able to resuscitate these conversations, particularly those with founders or families fatigued from running a company through a crisis.

Aim small, miss small.  Many of the sponsors looked inward during the first few months of lockdowns.  Based on anecdotal feedback and the data from the 2nd quarter, those firms continued to execute their tuck-in strategies for existing platforms.  This activity kept investment professionals busy and allowed them to show continued progress to Limited Partners.  Further, these tuck-in deals can be completed with little to no on-site diligence, so sponsors can build scale in their portfolio investments without risking life and limb to close a deal.  However, tuck-ins require very little fund equity so this activity does little to help funds meet deployment goals.  Funds need to start investing in platforms again.

The Incumbency Advantage

One of the insidious consequences of the pandemic is to further entrench incumbents across industries and professions.  This is natural during any economic crisis – people focus on triage situations and think less critically about suppliers, service providers and sourcing relationships.  In other words, you do not interview a new doctor from the back of an ambulance.  Social distancing exacerbates this problem. 

I put 4,500 miles on a Hertz[7] rental before it was done.  I am midway through a two-week quarantine before I circulate with my family again, pending a negative COVID test.  Looking back, my hygiene protocols kept me healthy and safe and I am extraordinarily grateful for the time that I spent with my clients, colleagues, family, and friends along the way.  In summary, this is a great time to refresh existing relationships, but a murderously difficult time to build new ones.  Upstarts have to retool their strategies for penetrating new accounts now that conferences and in-person meetings are not happening.  For incumbents, if you feel comfortable going out into the world, go see your customers, employees and other stakeholders.  You will be happy you did.

[1] She has completely recovered and doing great!  Thanks for asking.
[2] And Total Wine & Spirits
[3] I met only outdoors, only observing social distancing prescriptions and masked up.  Developing these hygiene protocols and then scrupulously observing them gave me the confidence to re-enter the world.  I also closely monitored local infection rates and stayed in compliance with state and municipal laws regarding quarantines while moving between geographies.
[4]  Social distancing, people!!
[5] In David Foster Wallace’s Infinite Jest, he foretells the boom and subsequent collapse of the Zoom zeitgeist:   
[6] Smaller funds that are in the brink of fundraising have been especially amenable to these discussions.
[7] Pro tip: rental cars are remarkably inexpensive right now.  Don’t take the depreciation on your own car.  The 2020 Nissan Altima is a very serviceable road trip mobile with great gas mileage and sturdy Bluetooth connectivity.