13 May 2021 M&A activity…A Robust Seller’s Market
Recap of Recent History
After coming to a virtual stop in April and May of 2020, M&A activity slowly came back to life last summer and gradually built momentum as the year progressed. The first deals to test the post-shutdown market largely involved sellers of companies that were COVID-resistant and that, in some cases, even benefitted from the effects of the pandemic (e.g., household cleaning products, food packaging for grocery items, ecommerce platforms). Buyers generally reacted favorably to these opportunities due to pent up demand and the scarcity of such favorably positioned targets. Valuations held up well considering the backdrop of negative economic news, and for those companies that were particularly well positioned, valuation multi-ples rivaled pre-pandemic expectations.
As the chart of quarterly M&A activity below indicates, after the sharp decline in Q2 of 2020, deal closings rebounded in Q3, increasing by 33% over Q2 results to 3,014 deals. That pace accelerated even further in Q4, with 4,156 deals reflecting a 38% increase over the prior quarter and the largest quarterly volume of deal activity over the previous 2-year period. While down modestly in Q1 of 2021 from the prior quarter’s results, deal closings for the quarter continued at a strong pace that compared favorably with pre-pandemic levels.
Aside from certain industries that were particularly hard hit by the effects of COVID-related shut-downs and restrictions (e.g., travel, hospitality, entertainment, brick-and-mortar retail), buyers found deal opportunities in a broad cross-section of industries as many companies were able to isolate the negative effects of the pandemic and demonstrate a path back to pre-COVID performance levels.
2021 Update and Outlook
Building on the positive deal momentum experienced in the second half of 2020, most participants in the deal-making community are expressing optimism for M&A prospects for the remainder of 2021. According to a recent survey of M&A professionals conducted by the Association for Corporate Growth, roughly 75% had a positive outlook for expected M&A activity for 2021. This is especially true for companies that were resilient to the negative effects of COVID-19. The relative scarcity of these companies along with the attractive risk profile they present for buyers and lenders is producing a real, and at times significant, valuation premium.
So, what factors are driving such a robust level of M&A activity in 2021?
1. Rapidly improving macroeconomic prospects – Generous amounts of fiscal stimulus, low interest rates, declining unemployment, and the accelerating rollout of COVID-19 vaccines have resulted in greater confidence among consumers, business leaders and investors, all of which are key ingredients to economic growth and corresponding levels of M&A activity.
2. Availability of investment capital – Given the historical returns generated by private equity firms, in-vestors continue to pour ever increasing amounts of money into these investment vehicles. By most estimates, the amount of investment capital currently available to the private equity community is ap-proaching $2 trillion, an increase of roughly $300 billion in just the past year. Well-positioned sellers will continue to be the primary beneficiaries of this abundance of funding in 2021, as private equity firms compete among themselves, as well as with strategic buyers, to identify and acquire investment worthy acquisition targets, and ultimately, satisfy investors’ expectations.
3. Increasing supply of acquisition targets – As the large population of baby boomer business owners (now between the ages of 57 and 75) reaches the age of traditional retirement, more and more of these business owners will be seeking some type of liquidity event. This willingness to consider a sale transaction is accentuated by the fatigue associated with the fact that we are currently experiencing our second “once in a generation” recession in a little over a decade. Finally, the reality that we are now likely to see a substantial increase in capital gains tax rates in 2022 has moved an increasing number of closely-held business owners, many of whom have a very low tax basis associated with the equity in their business, to accelerate the timeline for exiting their ownership.
We are mindful of potential headwinds that could slow the positive momentum currently shaping the deal market in 2021. Those potential headwinds include variant strains of COVID-19 potentially leading to new shutdowns, lingering high unemployment, on-going geopolitical and trade tensions, and setbacks in the economic recovery for certain industry sectors and regions of the country. However, by most indications, 2021 promises to be an active environment for M&A.
Buyers, both strategic and financial, looking to accelerate business transformation and growth strategies have ample access to capital and a rising level of optimism regarding continued economic progress. There should also be an ample supply of available targets, as aging business owners accelerate their timetables for liquidity events, and certain sellers re-approach the market after plans for a sale transaction in 2020 were put on hold. All in all, we expect to see the continuation of a robust seller’s market for the remainder of 2021, with fierce competition among buyers for well-positioned sellers in high growth industries.