As a record number of firms trade hands, buyers are increasingly seeing companies on the block passing off Covid-related revenue surges as normalized earnings. Diligence efforts now revolve around understanding the reliability of earnings. “Some companies have seen a Covid bump, actually,” says Bain Capital Credit’s Michael Ewald, noting that targets are now saying “’Our last twelve months might be higher but for being shut down for a month.’ They’re arguing we’re going to stay high, so that’s what we’re keeping an eye out on.”
It’s a sentiment shared across industries. Traub Capital Partners’ co-founder Brian Crosby notes that consumer sector firms are marketing themselves off of peak earnings driven by supermarket binges, while restaurants remained shuttered. And an uptick in valuations across industries suggests multiple expansion is widespread.
“There have always been Ebitda adjustments,” Ewald notes, putting the trend in context. But the rush of companies coming to market does appear to have inspired a wave of pitches around a new definition of ‘normalized’ earnings.
That might be another motivation in the rise of earnouts in merger agreements. Instead of mitigating pandemic-related earnings gaps or labor shortage setbacks, the contracts could be deployed to insulate buyers from inflated figures. Grant Thornton’s national managing partner for M&A Elliot Findlay told us respondents to his firm’s dealmaker survey expect a “significant increase” in earnout-related disputes.
Meanwhile, dealmakers continue to exercise increased scrutiny despite the deluge of deals.