Extra due diligence considerations for COVID-19

Geert Struyven, Partner, Corporate Finance

We are now starting to see some more opportunities for our transaction support teams nationally and we are often being asked what impact COVID-19 has on our typical due diligence scope.

At the start of the lockdown, management teams switched their focus from mid- and long-term growth strategies to immediate crisis and cash management. Equity investors also switched their focus from deal origination and deal execution to their existing portfolio companies to assess the impact of COVID-19. Some sectors are impacted more than others, but pretty much all investors had to take stock and assess the implications of COVID-19 on their business. There were few M&A transactions completing, and those that did, were mainly businesses in sectors less likely to be affected by COVID-19.

Now that portfolio companies are under control, with operations either largely mothballed or operating under a new normal, deals are slowly starting to come back, in particular deals that were already in discussion or in process prior to COVID-19 but were then put on hold. We expect deal structures to be more complex and hence extra attention may be required on tailoring the due diligence scope. For a start, I expect to see more earn-outs and fewer Locked Box transactions in the current market.

Whilst physical distancing and limited public transport are likely to continue for some time, this is no longer stopping transactions from proceeding. In our experience, investors are still keen to have site visits and physically meet the management teams, albeit with some socially distancing restrictions in place which are now possible after the slight easing of the lockdown. After the initial person-to-person meetings, most of the courtship then continues over video conference calls.

We were already experienced at working remotely before the current pandemic and have been using online data rooms, with the traditional initial kick off meetings now being replaced by video conference calls. The main impact is therefore on our financial due diligence scope. Why do lots of work on the historical performance KPIs when the future may be rather different?

Furthermore, the recent performance may well be affected by the manufacturing close down, supply delays, reduced demand, furloughing, temporary pay reductions, delayed customer payments, rent deferrals, increased customer churn, postponed or cancelled capex and variety of other one-off and non-recurring anomalies, which all mask the underlying performance. As a result, developing a clear picture of the performance during and after the lockdown may not be straightforward. Historical business information may be less useful and will have to be carefully scrutinized as an accurate predictor of future performance. There will be increased focus on up to date and forward-looking information, including budget forecasts and order books.

FDD providers must understand management’s response to the crisis and the effects on the current as well as long-term operations. Understanding actions taken in response to COVID-19 will help investors assess the strengths and agility of management teams.

Assessing underlying performance

One of the tools recently being touted on social websites is the new ‘Earnings before interest, tax, depreciation, amortisation and coronavirus’ (EBITDAC) measure. Vendors and their advisors have always strived to present their financial results in the most flattering light and we are well versed to review these adjustments with a healthy pinch of scepticism. In this case, it appears that these are lost earnings one is seeking to add back, as opposed to adjustments for potential cost savings or one-off events that are clearly defined in time and measure. At the present time, the medium to long term impact of the pandemic on the business environment at large are still unknown, and therefore I don’t consider EBITDAC to be a particularly useful measure at present.

The key focus should be to understand the ‘new normal’ for the company. EBITDAC may well become an interesting measure once the lockdown is released and ‘normal’ trading resumes to similar levels as before the pandemic. Until then, I believe it is likely to be impossible to assess the real underlying EBITDAC. As such, the scope of FDD needs to be clearly defined and fine-tuned for each individual project. The immediate may be to look for negative impacts, but one should also consider positive changes or one off benefits that the Company may experience


It will be key to assess the impact of COVID-19 on revenue by reviewing sales trends before, during, and after the pandemic by customer, product, end-market, and channel. This will provide a structure for assessing which key factors will most impact the top-line performance. We have outlined some questions to consider.

  • Is the business exposed to significant concentration across their product range, customer base or supplier base?
  • What level of interaction has the company had with its customers and suppliers to assess their financial stability?  How secure is the supply chain of our suppliers?
  • Is there any risk of goods or services being delayed by travel restrictions? What other logistical or financial hurdles may exist? Does the company have reliable sources for the timely delivery of quality materials, and will those relationships survive the pandemic? 
  • What is required to return demand or production to pre COVID-19 levels?
  • Will there be permanent changes to the supply chain and product pricing as a result of COVID-19? Some companies may change their standard T&Cs with increased acceptance of returns and discounting in response to changes in aggregate demand. Other companies may find limited supply provides opportunities to increase pricing.
  • Does the company have vendor agreements with purchase commitments?

Gross Margin and EBITDA

To assess the immediate impact of COVID-19, compare the Revenue and EBITDA run rates before COVID-19 (on a seasonally adjusted basis) to the impacted months and management’s near-term forecasts. Compare the current performance against growth rates from prior years and future year projections.

Once the financial performance appears to be stabilising for a series of months, the annualisation of EBITDA for the most recent quarter(s), adjusted for seasonality, may help determine the impact of COVID-19.

Some additional considerations

  • Has there or will there be a material change to the cost of production or cost of sales as a result of implementing safety measures. What is the impact on margins?
  • Has there been increased cost of purchases as a result of COVID-19 or due to changes in volumes?
  • How long can the business survive this economic downturn and how can it trade itself out of the current position. How much investment is required? How will a phased return to work impact the business?

Payroll is commonly a company’s most significant expense. It is therefore important to understand the financial or operational ramifications of the company’s HR decisions.

  • Make sure the headcount and labour costs during the crisis reflect the true ongoing costs. Did the business temporarily reduce employee salaries and suspend performance payments?
  • Will the company be able to rehire the external consultants and agency staff needed to resume operations, especially skilled and experienced staff?

Net Working Capital (NWC)

The simple use of a simple historical average (12 months or 6 months) is unlikely to be appropriate as historical working capital may not accurately reflect working capital needs going forward. One will not only have to consider the pre-lockdown NWC profile but also how NWC has behaved during lockdown (and, understand the reasons why), and crucially, the expected profile and associated cash absorption for a return to a normal or ‘new normal’ level of NWC. 

Particular attention may be needed to changes to terms of trade and/or payment periods during lockdown.

Cash free Debt free

The traditional accounting methodologies may not reflect all the ‘debt-like’ items and a fresh look at the accounting methodology may be warranted to identify any additional debt like items, examples include the below.

  • Has the company updated its allowance for bad debts to reflect the risk inherent in its customer base?
  • Consider the need for additional inventory reserves for spoilage, slow-moving, excess and obsolete inventory as a result of the slowdown or change in demand.
  • How is the company accounting for the government support and are liabilities clearly recorded?
  • Are there any stretched creditors?
  • Are there normalised levels of inventory and what are the implications if not? Is the business likely to run out of stock or has it built up unsustainable levels of stock?
  • What is the holiday provision for furloughed workers?


Forecasting will be even harder than usual and will involve a range of potential scenarios, depending on the duration of lockdown and social distancing requirements, the reaction of the consumers and the extent of further government support. Businesses should be preparing regular short-term cash forecasts (e.g. 13 weeks) that reflect the latest impact of COVID-19 on operations, supply chains, staffing levels, customers and the current order book.

We expect these forecasts to change as the situation evolves including during the FDD and leading up to completion but management should be carefully considering this as this will directly impact value, either by setting net assets hurdles at completion or in structuring earn out scenarios. 

We expect to critically review and comment on these short term and longer term cash forecasts on all FDD projects for the foreseeable future. Clearly documenting and validating the assumptions will remain key.

For more information, contact Geert Struyven or your usual Crowe contact.

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Geert Struyven
Geert Struyven
Partner, Corporate Finance and Head of Valuation Services