EBITDA

At PEM Corporate Finance we live and breathe EBITDA – it’s the performance metric of choice for M&A advisers and valuers alike as, at least in simplistic terms, it’s a good proxy for cash flow. And ultimately it’s cash flow that a corporate purchaser, investor or valuer ought to be focused on.  That’s what they’re buying or valuing.

EBITDAC

Of course EBITDA needs to be cleaned up before use, often adjusting for the true economic costs of the directors, and adding back any one offs costs. One might think it would be enough to consider the effects of Corona Virus on business, be it in reduced sales, margins, disrupted supply lines, or increased debt, as an add back. But in fact a new acronym has been coined: EBITDAC or earnings before interest tax depreciation and corona.

You can even get it on a mug!

How might it help in practice. Well it will depend on how readily you can quantify and clearly identify the effects of Corona. That might not be altogether straightforward. It might hit the business in many ways, some of which won’t become apparent until later. It is also likely that the Corona effect will vary over time, and by sector. So for example we’ve found that some businesses are picking up slowly after an initial hit, and some sectors particularly in tech weren’t much impacted.
I do think it’s worth trying to isolate EBITDAC. It’s going to be an ongoing difficulty for business valuers. But in M&A there are some immediate impacts:-

Price expectations

Coming out of the recession that followed the financial crash in 2008/9 one of the issues was a big gap that had opened between vendors and purchasers expectations as to price. This could be an issue in the short term now. Vendors will want to sell on the back of the EBITDAC profit metric and on pre-Corona multiples. Buyers will want to back off some of the risk that the current reported EBITDA is the new normal through a reduced price. In practice we’re already seeing the use of earnouts, convertible instruments and ratcheted deals to bridge this gap. Creative deal structuring is going to be needed.

Locked box v Completion accounts

The locked box has become quite common and is especially popular with private equity buyers as it gives them certainly as to price/structure and their funding requirements to allow them to draw down funds if needed. However in a fast moving situation where there’s ongoing uncertainty as to how Corona Virus will impact it may now suit both buyer and seller to move to Completion Accounts where the final deal structure is established on completion. It’s quite likely that deals will progress slowly over the summer as buyers and funders are cautious with their diligence – that further emphasises the need to see what the world looks like on completion if that’s going to take to the autumn.

Normalised working capital

Upon closing an M&A transaction there is always a debate around the normal level of working capital, and what are the debt like items are in the target. And from that just how much surplus cash can be taken off the table by the Sellers. Of course short term there’s a good chance that working capital will not be normal, with a build up of creditors on stretched terms quite likely – and so that needs to be dealt with.

Just how much use is EBITDAC anyway?

Short term I’d say it’s interesting, we must use it, but as a proxy for cash flow it’s useless and that will ultimately limit its applicability in M&A without consideration of other factors such as the fundamental value drivers of the business, it’s forecasts and scenario planning for 2021. As far as valuation opinions are concerned 2020 EBITDAC can only really be used alongside consideration of 2019 results, and a detailed scrutiny of the business fundamentals and prospects for 2021.  It really underscores the need to start planning now for the recovery, as it will be all about having a credible view of 2021 and beyond.   

For more on business valuations and corona have a look at our valuations site or this article on the PEM Corporate Finance site 

Today's the day that the government's Job Retention Scheme gets going in earnest with the portal open for firms to apply for payment.   And the word Furlough has well and truly re-entered the language with many firms already having Furloughed staff, and which will now be applying to get the grants.  I know that my tax colleagues have been active today helping with this.

If you were being unkind you'd say that that government's support for business whilst swift and very welcome was full of gaps.  These are gradually being filled.  The Corona Business Interuption Loan Scheme (CBILs) was onerous in terms of the guarantees required from business.  But now the guarantee requirements have been softened.  Then there was a gap above CBILs and below the Corvid Corporate Financing Facility for larger businesses.  This has now been filled with the Coronavirus Large Business Interruption Loan Scheme (CLBILS) .  Incidentally why the confused approach to naming these, one's Coronavirus, and other Corvid?

All this still leaves a gap for businesses that don't pass the viability test for CBILs - ie that it would have been viable in 2019 and will be in 2021.  Such businesses are going to have to look to other sources of finance, including the various tax related supports that have been made available, and negotiations with their creditors.  Expect to see the insolvency practitioners busy with a rash of CVAs, prepacks and phoenixes in the Autumn for those firms that can get through until then.

And yesterday the Chancellor announced a £1.25Bn rescue package for start-ups.  He intends to grant c£750m to start-ups through Innovate UK's network of funds.  And to set up the Future Fund which will channel £500m via the British Business Bank to suitable candidates.  Cleverly the loans are conditional on private investors putting in 50% of the money, which should help to filter out the lost causes.  The government will have some kind of equity conversion after three years unless the loans are repaid.  That either means that they'll be left with equity in no hopers, or will have soft conversion rights - or new investors would surely take them out.  But I guess that's a small issue compared with the other burdens the treasury is taking on to support business.

This must be welcome news for venture capital / private equity funds which I know have been closely monitoring their portfolio investments through this crisis.

So the safety net probably still has holes in it - but at least they're becoming fewer.  It'd be nice however if the gaps could  be filled before business groups have to start lobbying as was the case with the start-up community which looked enviously at the generous support in places like Germany, and lobbied hard for this.

We have a Corona Virus hub on our website with lots of information and also practical insights on how to access the right funds.

If you're grappling with how best to access this support, or would simply like to discuss your strategy, get in touch - I'd be interested to hear how you're tackling it.