Valuation has always been one of the tougher nuts to crack in M&A deals, even under normal circumstances. When you throw in a pandemic to the mix, things begin to become more challenging, but also more interesting. Join Domenic Rinaldi as he speaks with Howard & Howard’s Joe DeVito to discuss some of the creative deal structures that M&A parties have adopted to bridge the valuation and risk gaps that came as a result of COVID-19. While 2020 certainly has been a tough ride as far as M&A transactions go, there is no reason to believe that 2021 would be any easier, so this episode is a must-listen if you’re planning to strike a deal anytime soon. Listen in and pick up some cool ideas that you can use to close your own transaction.


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Joseph DeVito: Creative Deal Structures That Address Valuation And Risk Gaps During COVID-19 – Ep. 091

M&A transactions can be hard under normal circumstances. If you throw into the mix all the insurgencies of the pandemic, it can wreak havoc on transactions. There’s no doubt that doing deals is taking longer. Diligence is stretched out. Buyers are way more cautious and banks are wanting more and more data about the current and future performance of a business. As in most challenging deal environments, there’s always a way to structure a deal to meet the needs of all the parties. I’m being joined by Joe DeVito, who’s the Chairman of the Business and Corporate Group of the law firm, Howard & Howard. Joe has been doing Corporate Law and M&A deals since 1995. He’s well-versed in how to get deals done during trying times. Joe shares some creative deal structures to bridge the valuation and risk gaps that we’re all dealing with as a result of COVID. He’s a smart deal attorney.

I hope you can leverage some of these ideas to successfully close your own transaction or reach out to Joe. He’ll be more than happy to help you explore potential deal structures. We have created best practices and checklist for how to conduct diligence. This is a free resource available on either of our websites, or Take a minute to download this invaluable resource. It’s a great starting point for you and your advisors when contemplating an acquisition. Thank you for being here, and I hope you enjoy this episode.

Joe, welcome to the show.

Domenic, thanks for having me.

It’s nice to have you here. Thanks for taking some time. You’re with the law firm, Howard & Howard. We’ve been talking about what’s been happening in the marketplace. I know you’re seeing some different deal structures. We’re starting to see a lot of different things based on COVID. I’m excited to talk about some of the structures that you’re seeing. Take it up a level for us. What are you seeing in the marketplace for M&A? What are your lens to the market?

Let’s go back to February 2020 for example. Everyone was uncertain about what was going to happen. I think the deals that got done after that period were the deals of necessity and the deals that were already in the pipeline, if the financing held up on the deal, if there was financing. Those deals got done. What I mean by deals of necessity are ones that were closing out funds or that a fund felt it had to have to complete the portfolio companies in order to sell the portfolio companies including bolt-ons. You saw a lot of that. After that happened, in about mid-April 2020 timeframe, when the pipeline of deals that were already in the works closed out, it got quiet. I would say starting around June 2020 when everyone got their bearings, it took off from there and the deal flow was like drinking out of a fire hose again all the way through the end of 2020.

I think what happened was we saw that the people and buyers realized the deals that were immune from COVID or that benefited from COVID were all getting done. After that short pause, the sellers whose businesses were impacted by COVID got realistic about their multiples. If you remember, Domenic, we were coming off all-time highs on multiples and it was a seller’s market. It was a resetting of the multiple based for sellers whose businesses were impacted by COVID.

What are you thinking for 2021? Do you think that you’re going to still stay and remain in a robust M&A environment? Do you see things pulling back a bit?

I think it’s going to heat up again. It’s starting to already. It’s going to be a strong 2021. Once the large corporate M&A business development departments are kicking into high gear again and come off a pause, it’s going to be a hot year for M&A for sure.

What we’re seeing is a ton of activity on the buy side, a ton of buyers trying to source and find deals. We’re seeing a little bit of reluctance on the seller side because they’re understanding that if they were impacted negatively or even positively by COVID, that earn-outs are going to be a bigger piece of their transaction or some carve out. People are struggling with that. They understand it but they don’t like it. We see people dragging their feet. I’m not certain that they’re going to hold off on going to market, but they’re undecided and they’re dragging their feet for sure.

I’ve seen both sides of that as you described it. On a chemical company deal where we were representing the seller, they had a big uptick because of COVID. There was a special valuation as it related to the EBITDA, related to the hand sanitizer and other items that were COVID-related. The seller and the buyer had to bridge that on the positive side. On the downside, sellers were hesitant to sell because they knew they would have a recovery over time. They didn’t want to cash out prematurely and not get the full valuation for their company that they know they would get in another months, for example.

It’s always been a dynamic market when it comes to M&A, but you’ve got all these other forces sitting out there like tax reform. We might wind up seeing capital gains go from current 20% to maybe they’re talking about 39.6%. You wonder how much people do need to grow to bridge that gap. At least the people that I’m speaking with think it’s unlikely that we’re going to see that in 2021, but that it may be certainly on the docket for 2022. That’s going to take a big bite out of net proceeds if we see cap gains go up by that amount.

We saw a big push at the end of the year in 2020 to try and get some deals that could get done by the end of the year in 2020. I think people got realistic about multiples and got it done. At the end of the day when someone’s ready to sell or has to sell on a necessity, they’re going to sell and they’ll try to structure the transaction to lower the tax impact of that. Even in historic areas of higher capital gains rates in individual tax rates, we still have great deal flow. With the amount of money that’s on the sidelines with private equity, large corporates and then the family offices that are diving into it directly. There’s an amount of money on the sidelines that’s got to be deployed.

That begs the question on what we continue to see high multiples because there is that pressure to deploy all that capital. It will be interesting to see what happens. Let’s put our crystal balls to the side because we’ve tried to figure out what’s going to happen. I’m interested to dive into what you’re seeing from deal structure perspective. We had an interesting conversation and it looks like you’re starting to see some creative deal structures. I’m excited to dive into that. As you referenced earlier in the conversation, we’re seeing valuation gap, whether it’s to the positive side because companies have done so well or to the negative side because they had a negative impact as a result of COVID. What are you seeing that buyers and sellers are doing creatively to bridge those gaps?

MAU 91 | Creative Deal Structures

Creative Deal Structures: In the COVID era, numbers are bouncing all over the place. They’re either being pumped up or suppressed artificially because of the pandemic.


I think the basis of any valuation is understanding the numbers, having normalized numbers and recurring sustainable revenue and EBITDA numbers. When you’re in the COVID era, it’s bouncing all over the place. It’s either bouncing up to the high side artificially or it’s suppressed artificially because of COVID. What I’m seeing and what we’re having happen in deals is that people are working off at 2019 numbers. What they’re doing is they’re saying, “Let’s work off 2019 as a base and we’ll look back at 2018 and 2017 to make sure 2019 is a good number, isn’t artificial as well for one reason or another. We’re going to value the deal on 2019 with a couple unique structures to it.”

What we’ll do is we’ll either value it on 2019 numbers and have a whole back of 20% based on a recovery rate that occurs over some period of trailing time after the closing. What that trailing period is depends on the type of business and the rate of recovery that industry is experiencing. If the target company experiences the same rate of recovery, then within that eighteen-month measurement period, that 20% holdback will be paid. In exchange for that and with multiples being a little bit on the lower side in the case of a company that did get impacted by COVID, the sellers are asking for earn-outs on top of that. Traditionally, sellers hate earn-outs but they’re asking for them because they want some upside that if their recovery rate is in advance of the industry standard, they want to ring the bell one more time.

That holdback is a real holdback. You’ve got 20% that’s being held in escrow, whereas it’s not earn-out. It might go away if they don’t recover but different than an earn-out.

These are the deals that we’re already pricing pre-COVID. The parties had a meeting of the minds as it relates to the price. You slipped into the deal getting done in 2020, and then COVID hit and impacted the financials. In these instances, you’ve got folks that had already priced the deal. It’s a 7 times X, we’re going to take 80% of that. We’ll pay it cash at closing instead of 100% at closing, and that 20% if you hit your recovery within the eighteen-month period. The other thing that we’re seeing is what you call incremental purchases or creeping acquisitions. We have private equity buyers and large strategics that are purchasing a minority interest, an evaluation of X in the first tranche. We called it first tranche of X-1 multiple because of the impact of COVID.

They’re getting in and getting ownership at a lower multiple. They set it up so that they have then a controlling interest purchase, which comes in the second tranche in maybe 3 to 4 years when the company would be fully recovered. That would be at the original multiple that the parties had agreed upon. In that instance if you did 20%, a 40% in that second tranche and then in the third tranche, the final 40%, you’re doing X plus 1 or X plus 2. There’s an incentive for the seller to allow the strategic or the private equity in for less than a control in the beginning and less than a full multiple because there’s upside on six years down the road. Those usually end with a put call type of option in year six.

Is the thought behind this allows sellers to take some chips off the table and it allows buyers to get in and not assume crazy multiple risks?

The purchaser gets to lock up the target. There are some escape clauses, escape hatches in these deals but allows them in. They can do continuing diligence as a 20% owner, then they can decide if they want to go to the next tranche or or if they want to exit. The exits are built into the documentation as a part of the negotiations. The sellers in some instances are happy to have a buyer on board knowing that there’s an eventual full exit.

It's tough to diligence a company the proper way during COVID. If you structure it as an asset deal, you're a lot safer that way as a buyer. Click To Tweet

Joe, are the best practices on that deal structure that you’re agreeing to evaluation methodology right up front regardless of what happens to the company in the next years?

To be fair to both sides, having that pre-ordained formula in the documentation allows for the parties to understand and predict what’s going to happen, one way or the other, up or down. If the company performs, we’re going to do X. If the company doesn’t perform, we’re going to do Y. That’s the way it’s going to fall.

It’s a lot like a partnership buyout. You’ve got a partnership agreement right up front and you agree on the methodology. Depending on what happens, people can pull triggers or not pull triggers.

That’s a good point because the tricky part of these two structures on the governance as well. There’s a flip-flop on the control provisions, the minority owner protection provisions that flop to majority control. Do they stay the same for both parties? Do they fall off? The answer is they don’t stay the same because the strategic or private equity purchaser is going to have to have full control when they take a majority interest with minimal downside protections. When a private equity buyer or a strategic buyer goes in as a 20% owner, they have a laundry list of minority shareholder protections. That’s the nature of the beast and what market terms are.

Taking it away from the legal aspects, what should owners be thinking about when they’re contemplating a structure like this? You’ve got a good attorney like yourself and you’re going to button up the documents. You’re going to make sure there are legal protections. Beyond the legal protections, there are considerations, things that owners should be contemplating and thinking about. They’re getting into bed with a minority investor whereas they may have run the ship for years by themselves. This is a different kettle of fish.

In selling the 20%, you have to think in terms of you are giving up control to some degree. You have to be sure and certain that this is what you want because once you’re in and involved, it’s going to progress to the next step, these things naturally do and then have an exit. The final thing would be for an owner to be positive that they don’t want to sell the management or look at some alternative structure, which raises another point is that in these creeping acquisitions as well, you do also set up an incentive plan for management because the PE or strategic wants that so that the team other than the main owner is incentivized to grow it, and everyone’s interests are aligned and moving the business forward.

If you’ve been a sole shareholder of the business for years, you have people in your business. You have people in your kitchen. They know that you’re willing to share the kitchen with people and do your due diligence. Oftentimes, we talk about the buyers doing their due diligence but the owner has to do theirs as well. Make sure they’re getting into a deal with a party that they want to be in for the long haul.

I think it’s important. Our clients often do this and PE funds that have structured similar deals or that have a number of portfolio companies offer owners to speak to past owners that are either management, or have cashed out to talk about their experience with a specific PE fund. I do think that’s important to do the diligence. It’s important to work with a PE fund that has done a number of transactions in the past that are similar to what you’re doing. If it’s the first time they’re doing purchase of a minority interest, you’re going to have to do extra diligence on the front side and an extra documentation in terms of all the relative rights and preferences of the two parties. If it’s the first time for anyone, you’re going to have some bumps in the road.

MAU 91 | Creative Deal Structures

Creative Deal Structures: With the advent of COVID, we’re seeing a lot more asset deals, in which the buyer only assumes certain enumerated liabilities, while the rest of it stays with the seller.


Let’s talk a little bit about liability. Getting back to the legal aspects, does anything materially change in the indemnification’s liability, reps and warranty insurance? What’s impacted there when you consider doing one of these phased buyouts?

The first aspect about liability and a transaction is an asset deal versus a stock deal. With an asset deal, you’re only assuming certain enumerated liabilities and the rest of it stays with the seller entity. With the advent of COVID, we’re seeing a lot more asset deals. When we’re representing private equity or large corporate on the buy side, we’re demanding it’s an asset deal because of the PPP loans and the potential liability with that. With all of the regulation that came in so quickly with COVID as it relates to labor and employment laws as well, it’s tough to diligence a company the proper way during COVID. If you structure it as an asset deal, you’re a lot safer that way as a buyer. In terms of the indemnity, we’re seeing higher cash escrows and then we’re seeing use of transaction liability insurance. The TLI carriers are not covering certain matters that are related to COVID. You have to have a separate escrow for that or an avenue for indemnification.

We’re seeing banks still struggling with how to deal with PPP loans in the middle of an acquisition. There’s a lot more guidance than there was months ago, but we still see a lot of challenges here. A lot of advisors are not up on the latest in regards to this. It’s important that you have an M&A attorney that understands this that’s dealing with this day in and day out. On the accounting side, I’m sure you’re seeing that as well.

You have to have CPA firms or financial advisors that understand this. They’re doing on a daily basis and understand the impact of all the various elements of the target company, whether it’s the EIDL loan, the PPP or some other aspect of their business that impacts the financial statements. Understanding that and then explaining it in diligence.

Going back to EBITDA and multiples a little bit, should a buyer take comfort that they’re seeing the business go in the other direction? When are buyers jumping in on a deal? Do they have to see a month or two of recovery? Did they have to see a full quarter? What are they looking for to get some comfort that a structured buyout, an earn-out or a holdback make sense or they should walk from the deal?

Is the bottom falling out or is it a dip? Is there going to be a true recovery of it? I think that we’re seeing the diligence periods stretched out on purpose because buyers want to have a little more time to make sure everything is going the way it should be going and the recovery is sustainable. They’re looking at 3 to 4 months of seeing some recovery rate with a step up, an accelerated type recovery rate. When the purchasers see that, I think they get more comfortable with the deal, and they realize that it’s sticky and it’s going to be okay. If there are a couple of blips, then they might stretch it out even a little further. I’ve got a deal that’s going to go into eighteen months of diligence. It’s been extended for another six months because the buyer still wants to do the deal but they want to kick the tires a little more and see how this recovery comes in 2021.

We have a similar type of deal that died and came back. We are on the buy-side on the steel. They’re doing an enormous amount of diligence. One thing that happened which was interesting is the target company had an accelerated recovery, which wasn’t anticipated. When we were in the middle of it, it was struggling and the deal fell apart. Soon thereafter, the business turned the corner and had an accelerated recovery. While our buyer thought they were negotiating a lower price, it turned out to be the opposite, which isn’t all bad news because it’s shown how resilient the company is.

Sellers get that confidence when they come back from it. They get that confidence and then they demand a higher multiple. They want it to be the way it was eighteen months ago.

Even beyond that because it’s so resilient. It’s COVID-proof. What other stuff at a high level would be important for our readers to understand as it relates to approaching these COVID deals?

We can’t forget the other person in the room, and that’s the financial institutions and what they’re doing. They’re a little hesitant. There’s this whole wave of what’s going to happen with PPP and loan defaults in 2021. Everyone’s keeping a sharp eye on that. I’m in a deal with a healthy PE backs buyer and their bank, which is 1 of the big 4 banks in the US is being hesitant to not even loan but to allow the use of cashflow on a deal. As a seller, you want to make sure that everything is okay with their lender and their lenders approve the transaction. On the buy side, get out in front of it with your lender. What they’re doing is they’re requiring additional diligence. They want to make sure those numbers are sticky, sustainable and it’s going to be in a creative acquisition.

Strap in for the ride for 2021! A new wave of regulation is coming and change like that always makes for a rough road when it comes to M&A. Click To Tweet

Have you seen any material changes to the loan document?

I’ve seen the lenders require equity contributions to get a deal done even for private equity clients, which is a little unique.

We’re in a brave new world. A lot of the people that I’m talking to think we’re going to be here for quite some time. We might have a recovery here but there’s nothing to say that we won’t have another dip somewhere along the way or some other challenges that pop up. The best is we all learn how to deal with this and be creative. It sounds like you found some ways to do that.

I echo what you’re saying, strap in for the ride for 2021 because there’s a whole new wave of regulation coming and change that always makes for a rough road.

Joe, give a little bit about your practice, your area of focus and how people can get in touch with you.

I’m a Corporate Finance Attorney. I have a Master’s in Corporate Finance Law, any type of transaction of finance, M&A, IPOs, secondary offerings, all that good stuff. I’ve been doing it since 1995 and had a steady flow of deals ever since, a lot of good experience and a lot of great clients. What I do is I try to take that wisdom from the deals and I try to incorporate it into the deals that I’m working on to benefit the new clients. I can be reached at Howard & Howard. It’s [email protected]. It’s my email. I’ll even offer out my cell phone, (248) 765-9090. Shoot me a text or give me a buzz if anyone wants to discuss anything further, for sure.

Joe, I appreciate you coming on the show and sharing your wisdom. These were some creative ideas that will hopefully give some of our readers’ thoughts on how they can get their own deal done. Thanks for visiting with us. I appreciate it.

Thanks for having me, Domenic. I truly appreciate it. Take care.

Thank you. Bye.

I hope you enjoyed this episode. If you enjoy our content, please remember to subscribe and review our show. I look forward to seeing you again on the next episode. Until then, please remember that scaling, acquiring or selling a business takes time, preparation and proper knowledge.

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About Joseph DeVito

MAU 91 | Creative Deal StructuresFounded in 1869, Howard & Howard is a full-service law firm with a national and international practice that provides legal services to businesses and business owners. Joseph DeVito is the chairman of Howard and Howard Attorneys PPLC’s Business and Corporate Group. He concentrates his practice in business financial transactions and real estate matters, including mergers, acquisitions, and reorganizations of business entities; complex commercial and real estate lending and restructuring transactions; international business transactions; real estate sale and leasing transactions; securities law and private placements; and healthcare-related corporate matters.
Joseph formerly served as assistant general counsel responsible for mergers and acquisitions for ThyssenKrupp in North America, and has also served as interim general counsel for corporate clients in the automotive, technology, and service industries, and in such capacity has advised members of management on all aspects of corporate, financial, and real estate transactions (both domestic and international), as well as securities issues.
His extensive experience includes negotiation and consummation of mergers and acquisitions, reorganizations, combinations, and joint ventures, including certified Minority Business Enterprises, negotiation and drafting licensing, e-commerce and other intellectual property agreements, negotiation and drafting of real estate purchase and leasing agreements, and various aspects of securities transactions and regulatory compliance.

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