This year has been fraught with global health concerns for everyone and financial burdens on businesses and individuals. But, has the government contracting space been impacted as well or is it business as usual? According to data reported on mergr.com, the number of closed mergers and acquisitions deals in the government contracting industry in the first half 2020 was down 14%, compared to the first half 2019. The average reported deal value was $594 million, while the average reported enterprise value (EV) to revenue ratio was 4.9x.

Number of closed deals in the first half of 2020 was down across all exit situations:

• Number of Private Equity transactions by PE firms – down 29%;
• Number of publicly traded prime contractor transactions – down 25%;
• Number of Private Equity exit transactions – 6

Exit Strategy Alternatives

With a lower volume of transactions in the first half of 2020 and a smaller buyer pool, set-aside and non-prime government contractors may consider other alternatives. Due to the decrease in M&A activity and limited liquidity options government contractors with small business set-aside contracts have, setting up an Employee Stock Ownership Plan (ESOP) may be an attractive alternative. Owners can use an ESOP to create market for their shares.

ESOPs additionally offer several tax advantages to other exit solutions, including but not limited to the following:

• Companies can get a current cash flow advantage by issuing new shares or treasury shares to the ESOP.
• Cash contributions to buy shares from current owners or to build up a cash reserve in the ESOP for future use are deductible.
• ESOP financing is done with pretax dollars (i.e. contributions used to repay a loan) which the ESOP takes out to buy company shares are tax-deductible.
• Sellers in a C corporation can get a tax deferral once the ESOP owns 30% of all the shares in the company. The seller can then reinvest the proceeds of the sale in other securities and defer any tax on the gain.

What’s Next?

For the remainder of 2020 and next year, any significant pick up in M&A activity will largely depend on the continuation of the COVID related economic activity slowdown. Manager-owners in the set aside and non-prime government contracting sector may look to alternative liquidity strategies as cash-flow pressures continue to mount.

If you would like to discuss whether setting up an Employee Stock Ownership Plan (ESOP) makes sense for your business, please contact Kathleen Kelley to discuss further.

This article is for informational purposes only and does not contain or convey legal advice. Consult a lawyer. Any views or opinions expressed herein are those of the authors and are not necessarily the views of any client.