As I reflect on my nearly 25 years in the middle market deal business, all I can think is, “wow, what a ride.” Now, witnessing the debilitating effect the Covid-19 pandemic is having on mid-market M&A and the corresponding debt markets, I can’t help but think, “here we go again.”
We have been here before.
All of us have witnessed our country in crisis. Most of us in the mid-market deal community have been around long enough to experience one, if not several, frightening disruptions to our businesses. For those of us that have watched markets plumb the depths, we have also witnessed recovery, and ultimately growth, time and again. In this regard, Covid-19 will be no different; our markets will recover, and I am one amongst many who are confident they will flourish again over time.
But there can be no doubt that we are in for a period of severe turbulence. It will take time for mid-market lenders to re-price risk. It will take time for troubles in loan portfolios to be identified and worked out. It will take time for robust liquidity to return to the credit markets that fuel so much of the M&A activity we rely on. And it will take time for buyers’ and sellers’ price expectations to return to equilibrium. To be sure, there will be winners and losers in this environment; those ill-equipped to adapt and evolve will find it difficult to survive. But is this necessarily a bad thing?
In the run-up to this latest crisis – just as with those before it – the markets had become a bit too frothy. Deal-making in the mid-market was just a little too easy. Debt packages were long on leverage and short on covenants. Mid-market investment bankers ran “meat grinder” auction processes that drove valuations to dizzying heights. And capital flows into middle-market private equity groups favored capital deployment over sound underwriting. Of course, the broader economy, with its low-interest rates, modest inflation, and near-zero unemployment, provided a safe haven to justify such irrational exuberance.
Successful deal-making in the middle market is not meant to be easy. If it were, everyone would be doing it. And we have seen some of that in the prelude to this crisis. Other mid-market investment banks amassed armies of professionals to cover sponsors and execute their trades. Auctions got broader while the quality of the offering materials deteriorated. Creative deal-making succumbed to volume deal-making. And so long as the carousel kept going around, no one was any the wiser. Everyone in the mid-market deal ecosystem was getting rich.
Covid-19 stopped the carousel. Lenders are reeling, fundraising has come to a screeching halt, and even our most erstwhile competitors are laying off bankers.
So, now it is back to basics. It will take time, but the markets will return, first to normalcy, and ultimately, again, to irrational exuberance. But near-term markets will favor the boldest and the most creative among us. Deals will have to be thoughtfully executed and creatively structured. Nothing will come easy. But, for those of us able to keep in place our teams of experienced deal professionals who have navigated similar markets in the past, the rewards will be plentiful. Just as the British encouraged their citizenry on the eve of WWII, we all must simply “keep calm and carry on.”