By Glenn P. Barenbaum, CPA

Despite a several months pause due to pandemic-related restrictions, merger and acquisition (M&A) activity was actually very robust in 2020. Both strategic and financial buyers continue to get deals done despite the unprecedented operating environment, often requiring CPAs to assist with their accounting and financial diligence. The demand to engage M&A advisers to assist in the diligence process has become more important than ever given the increased uncertainty of a business’s future financial performance, both during and after the pandemic.

Due diligence services provided by professional services firms are performed in accordance with the Statement on Standards for Consulting Services issued by the AICPA. While these services are not performed under AICPA attestation standards (no assurance provided), many corporate boards and private-equity investment committees rely on this professional service as part of their diligence process. Third-party diligence reports issued by CPA firms can be leveraged by banks financing these deals and may be a requirement of insurance providers underwriting representation and warranty insurance.

The Show Must Go On

Deals have and will continue to get done despite the global pandemic. In fact, the crisis is viewed as an opportunity by many investors. For corporate buyers in strong financial positions, the M&A market may be an opportunity to conduct deals with less competition. It’s also a good opportunity for corporations to evaluate their business units and decide to restructure or divest. Corporate carve-out transactions are complex, often supported by accounting subject matter experts in a sell-side assistance role to ensure the proforma financials are accurately presented. Private equity firms must also ensure “the show goes on” in 2021 in order to provide their investors with strong returns. According to Pitchbook’s 2021 U.S. Private Equality Outlook, it’s estimated private equity firms had about $1 trillion in “dry powder” available at year-end to get deals done.

COVID-19 Considerations

Apart from venture transactions or deals based on future technology, many businesses that are being acquired today are being evaluated on their projected run-rate earnings. The financial measurement that is analyzed during diligence to evaluate run-rate earnings is known as EBITDA (earnings before interest, taxes, depreciation, and amortization). The quality of earnings analysis (QofE) presents the EBITDA of a business after it is normalized for one-time, nonrecurring or unusual transactions. COVID-19’s impact (positive or negative) on EBITDA may be a “new” adjustment in 2020, but the concept of normalizing an unusual event is the essence of any QofE analysis.

Other financial elements that need to be considered during diligence include the benefits associated with the Coronavirus, Aid, Relief, and Economic Security (CARES) Act. One such benefit includes an employer’s ability to defer payment of the employer's share of Social Security taxes through Dec. 31, 2020. Businesses may have also been eligible for the Paycheck Protection Program. The debits and credits of both transactions should be understood and taken into account.

Stick to the Fundamentals

There are several new elements that should be considered during COVID-era deals, but there are three key financial analyses that need to remain the focus:

• Quality of earnings – QofE analyses use EBITDA as a proxy of operating cash flow. Understanding the operating cash flow generated by a business is critical to the financial modeling and overall evaluation of a business.
• Net working capital – By definition, net working capital is the difference between current assets and current liabilities. Net working capital is typically evaluated on a cash-free and debt-free basis, but net working capital levels can also be affected by COVID-19. For example, given the global disruption of the virus, certain supply chains have been disrupted causing some businesses to build up inventory levels.
• Debt and debt-like items – Any financial diligence should identify reported debt and other future potential cash commitments (debt-like). Legal commitments and contingencies also need to be identified and defined in the purchase agreement.

Is Anything Different?

The most pronounced difference in conducting diligence during the pandemic is the inability to travel and meet management in person. Given safety concerns around travel, state restrictions, and company policies, most teams are conducting diligence remotely through virtual meetings. What used to be two to three days of in-person meetings to work through the diligence process has transitioned to several three- to four-hour virtual meetings.

Same Formula, Different Approach

In the end, conducting financial diligence during the coronavirus pandemic is not that different than pre-COVID-19 days. Our profession encountered similar circumstances after 9/11 and the 2008 financial crisis. No matter the environment, identifying deal issues, understanding the implications of those issues, and suggesting how to mitigate risks is the tried and true formula to be a value-added strategic adviser. The financial diligence formula hasn’t changed during the pandemic, just the way it is conducted.

Glenn P. Barenbaum, CPA, is strategy and transactions managing director at Grant Thornton LLP in Philadelphia. He can be reached at glenn.barenbaum@us.gt.com.

You can learn more about the latest in mergers and acquisitions at PICPA's Transaction Advisory Services Conference Webcast on Oct. 26-27.

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