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And then it collapsed.
You remember: The spring of 2020, in 90 days, M&A deal volume plummeted 80 percent. It was one of the worst M&A quarters in history.
As the summer of 2021 approached, things began to change. Quickly. COVID-halted deals began to return. And once vaccinations took a significant foothold, potential acquisitions began to look a lot better.
In a recent Financial Times article, Anu Aiyengar, co-head of global M&A at JPMorgan Chase, said: “Outside Covid, this was a good environment for deal making. The equity markets were high, interest rates were low and equity investors were happy to pay for growth.”
“It’s been a year of two halves,” said Piers Prichard Jones, a partner at the corporate law firm Freshfields, told FT. “We, like everyone else, saw the first half being impacted by threats of the virus, the arrival of the virus, and the uncertainty Covid brought. From the start of the third quarter, you saw a level of confidence which meant people became more pragmatic about doing deals.”
“The year of two halves” left Q1 and Q2 essentially shut down as companies scrambled to move online and manage remote workforces. Executives were too busy to worry about acquisition, and deals got off to the slowest start since 2013.
But, as Bloomberg notes, two-thirds of the year’s deals were inked after July 2020, with over a trillion dollars announced in the fourth quarter alone.
M&A Picks Up Steam
According to data provider Refinitiv, Q1 2021 M&A activity skyrocketed 94 percent from Q1 of the previous year, reaching a staggering $1.3 trillion in value—the second highest in history.
John Stoltzfus, chief investment strategist at Oppenheimer Asset Management, told Forbes that the M&A fury has been driven by low borrowing costs, as reflected by low interest rates, and a surging stock market that has allowed highly-priced companies to acquire other firms using their own stock to make acquisitions.
Scott Barshay, chair of the corporate department at Paul Weiss Rifkind Wharton & Garrison law firm reported to Bloomberg, “All of a sudden, you could see a real shift in thinking to what the world will look like post-pandemic; how do we put ourselves in the best position to succeed when this ends? It seemed to be coming all at once from companies in every sector.”
Barshay and others point to the stabilizing impact of Joe Biden’s victory, combined with surprisingly good vaccine progress and low interest rates as the fuel to open the M&A floodgates.
Steve Ronan, principal at Citrin Cooperman, adds the pandemic scare was a driver: “Many companies that planned a mid-to-long term transaction were put under tremendous stress during the pandemic. Once they recovered—often aided by one-time federal assistance programs—the risk of ownership became more apparent and convinced them to go to market while valuations were still high. There is data, and many colorful anecdotes, about companies commanding higher than expected multiples, and many business owners want to take advantage of this.”
Roy Stein, managing partner at Orchid Black, has built and led best-in-class operations for businesses across multiple industries and countries, from billion-dollar enterprises to high growth startups.
He sees brisk M&A activity continuing: “Of course it will vary by sector, but there's still a lot of dry powder on the sidelines searching for solid investments. Bain Capital recently closed an $800 million fund. They were looking to do $500 million, and were oversubscribed. There’s a lot of money out there and people want a hedge against the market.”
“For instance, we are currently working with an energy storage company with a very impressive pipeline, market solution and experienced management team that forecast profitability in late 2022.” Stein continues, “The CEO is looking to raise $20 million. He’s had over 50 firms reach out requesting appointments with some going straight to their deal teams to begin due diligence.”
BEI Exit Planning Solutions is seeing increased activity as well; they point to aging owners as a driver: “The silver tidal wave is not finished,” notes strategist Aaron Dube. “We see a lot of baby boomers who are 65 or 70 still running companies. Typically, health events crop up before then. Or, other reasons that a company has to sell. That’s when you see fire sales. Smart owners are keenly aware of these possibilities, so they’re beginning exit planning now.”
But there could be a hiccup in M&A, thinks Mark Parrott, chief executive officer of Creative Retirement Planning. “There’s a ton of money out there right now, mainly because private equity is flush for cash, and driving the marketplace is the stock market. Private equity has money burning a hole in their pocket, and they’re looking to deploy it as quickly as possible. When the stock market is red hot, that translates to a better environment for publicly traded companies. And the market hasn’t collapsed yet, but it will.”
There are other factors besides the market, adds Howard Joyce, managing partner at Orchid Black: “The pandemic had negative or positive effects depending on the industry sector, exposing potential opportunities and weaknesses in many businesses. As things come back to normal, you are going to see M&A activity to capitalize on these opportunities or shore up the deficiencies. This activity is going to provoke soul-searching for a CEO/Founder. Pre-pandemic, they may have been planning to sell their company in five years , but now they are probably doing the math and pulling their timeline forward. And then there’s the potential tax increases...”
While a narrowly divided congress may have something to say about it, the potential of Biden’s 28 percent corporate tax looms large. Oppenheimer’s Stoltzfus told Forbes that could boost M&A activity globally and . . . the industrials, energy and materials sector could see increased M&A activity later this year.”
Biden’s tax hikes would affect wealthy taxpayers income, the sale of their investments and the transfer of their assets when they die. The top individual income tax rate may increase to 39.6 percent.
The New York Times reports: “Taxes on capital gains for people earning more than $1 million would be taxed as ordinary income, effectively increasing the rate wealthy individuals pay on that money to 39.6 percent from 20 percent. Because capital gains income would also still be subject to a 3.8 percent surtax that helps fund the Affordable Care Act, the Tax Foundation estimated high-earning taxpayers in some states could face tax rates on their capital gains that are above 50 percent, the highest such tax burden in a century.”
“The tax on capital gains would hit two-thirds of capital investment,” Neil Bradley, the U.S. Chamber of Commerce chief policy officer, told The Times. “The tax on corporations would hit 1.4 million small businesses and would impose on America’s largest businesses the highest tax rate in the industrialized world.”
In addition, tax worries exist beyond the current Biden proposal. The Tax Foundation points out, “There are tax increases scheduled over the next six years. The Tax Cuts and Jobs Act individual income tax provisions are scheduled to expire at the end of 2025, along with the phaseout of several business tax provisions between 2021 and 2026.”
Aaron Dube at BEI sees this as a primary driver of current M&A activity: “A lot of people are seeing the estate tax and capital gains taxes changing, moving north. So they’re trying to get in front of what those tax implications are going to be. And I think you’re going to continue to see this momentum, unless capital gains get so unruly owners feel they can’t sell.”
Deloitte, in an M&A Tax Talks report, sees significant acceleration of M&A deal activity in anticipation of these proposed income tax rate increases. They note, “business owners (corporations and individuals) that are contemplating such a transaction may be motivated to close a transaction before the potential increase in tax rates.”
“When planning for an M&A transaction,” the report continues, “buyers and sellers should consider evaluating these proposed changes and the potential impact they may have on transactions now. The potential increase in tax rates and value of future tax attributes, such as net operating losses and tax basis step-up, should all be considered when projecting future cash tax flows, analyzing potential outcomes, and considering appropriate tax planning alternatives.”
Are You Ready?
Improving markets and low interest rates point to a continued M&A growth throughout 2021, led by consumer discretionary, transportation, health care and financials. And even if some technology companies may look overvalued, AI, ML and advanced analytics will continue to transform healthcare, automotive, and IIoT in the post-pandemic world.
Looking forward, Cary Kochman, co-head of global M&A at Citigroup told Bloomberg that businesses have learned a lot: “The coronavirus also revealed vulnerabilities that pushed CEOs to make changes now, instead of in five or 10 years like they were planning. What this shock has done is force rapid implementation of these strategic plans.”
Aaron Dube of BEI agrees that strategic planning is critical, especially when it comes to M&A: “It’s how you better engineer your outcome. It’s about more than a buy/sell or an estate plan, a business return or auditing financial statements, it’s a strategic plan, the big picture.”
That includes factors such as how long the owner wants to be involved, the current business value, and creating transferable value—getting the value out of the owner’s head, bringing in a managed team optimizing the operations.
“It’s important to transition your mindset to ‘how do I create liquidity,’” says Dube. “If you’re not starting that plan, that’s when we see fire and asset sales. It doesn’t matter when you’re going to sell, you need to be planning now.”
Not surprisingly, BCG’s 2020 M&A Report notes that most deals fail for three reasons, all around planning and operations:
Mark Parrott teaches economic theory and extreme value creation to CEOs of privately held companies. He agrees that founders and CEOs must move from tactical to strategic thinking. “To build value, they need to think through the big picture, including utilizing demographics to predict the future, understanding and diversifying their customer base, strategizing on creating a durable sustainable company—how to create extreme valuation, and why growth services are so important.”
Steve Ronan agrees that readiness is key, even more than timing: “The value you will get in a transaction will likely be substantially greater if your company is ready, rather than if you rush to avoid tax policy or try to take advantage of a valuation trend.”
To prepare, Howard Joyce points to a proven bifurcated approach: “First, prepare yourself. What is your perspective on time, value and control? Time is when you want to sell, value is how much financial value you need, and control is how much control you want or personal commitment you’re willing to make. These three elements are interlinked. The value you want may not be achievable in the time you want to sell, or the transaction may require a post-deal commitment, which is not in line with your control expectations.”
“Next, prepare your business,” Joyce says. “This means conducting a dispassionate review of the company’s strengths and weaknesses in five focus areas:
Out of this you build a roadmap, include areas of short-term remediation, as well as things to amplify to a potential investor and areas to de-emphasize. The end-goal of this should be a comprehensive plan, a compelling narrative around the company and its strategy.”
Gartner predicts M&A is not slowing down anytime soon. Not this year, not next. In fact, they suggest that in 2022, “The level of global M&A activity involving technology providers will surpass previous highs recorded in 2018.”
Orchid Black’s Conclusion
The bottom line: It’s never too soon to prepare for the future. The opportunities to drive maximum valuation, mitigate risk and align stakeholders are vast and complex. The requisite skills to deliver successful outcomes are a blend of art, science and experience, very different from the skill sets to build a business. There are countless consultants and advisors offering support services with varying business models. Find the best partner who is fully aligned and invested in successful outcomes.
Orchid Black is a boutique advisory of former CEOs, CROs, CMOs, strategy execs, and board members. We are accomplished operators with an investor mindset and deep M&A experience.
Like an orchid, a company’s maximum value emerges from cultivating growth. Orchid Black’s unique business model not only accelerates value, but aligns our compensation with our partners' success. We invest together, betting on a collective vision, using shared skills and expertise.
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