Middle Market M&A Mindset – Spring 2021

By Russ Warren Managing Director,
Business Development

Middle market acquisition activity has rebounded from its severe dip in the first half of 2020, and more business owners are becoming mindful that this may be a good time to transition their business.

The graph below shows the pattern of the recovery in numbers of transactions announced.

Source: Capital IQ

Due to the following reasons, we expect the current market strength to continue through 2021 and possibly 2022:

• Plenty of capital available – Acquirers have access to very low-cost debt paired with $1.7 trillion of dry powder in the hands of private equity firms and other professional acquirers. Strategic acquirers have massive available debt capacity due to their strong balance sheets.
• High demand for middle market businesses that are coming through the COVID-19 pandemic with bright futures. The insatiable appetite for add-on and platform acquisitions exceeds supply, resulting in pricing that is attractive to sellers.
• The “9/11 Effect” – owners re-thinking what they want to do with the rest of their lives after coming through a traumatic experience – the COVID pandemic.
• Concerns over possible corporate and capital gains tax rate increases

We have seen the first two conditions for a quite a while, although they each have grown stronger as acquisition vehicles continue to raise massive funds, banks compete to lend and the supply of companies in the market now are depressed while some owners contemplate what the ‘new normal’ will look like. Across industries, some businesses were hurt (e. g., travel, entertainment), while others (on-line retail, and building materials) went on or even grew due to new opportunities that emerged with changes in consumer spending behavior and supply chain patterns.

But the third transition driver, sometimes called the 9/11 Effect after the trauma of terrorist attacks, resurfaced after a 20-year hiatus when many owners reflected on their experience of leading the business through a pandemic, and in the process thought more deeply about life and what matters most – be it family, ‘paying it forward’, starting another business or career, or leisure time to pursue a passion or pastime, including travel (when available). In a 2020 EdgePoint survey of business owners who sold, a key finding for satisfaction after the transition was “running towards something,” rather than “running from something.” At closing, only 36% of these owners thought it was important to have clarity on their post-business life; but looking back years after the event, 50% said it was important. Today’s Baby-boomers (born 1946-1964) who are still in the saddle, and a surprising number of younger owners (Gen-Xers) who want a “second act” while they can enjoy life are asking themselves, “what do I want to do?”

One further timing consideration is, “how much will I get to keep if Federal corporate income tax and long-term capital gains taxes are raised?”

• Currently at 21%, it has been proposed that the corporate tax rate be raised to 28%. How much would revenue need to grow to offset that 33% tax hike?
• Capital gains rates could be raised (most likely in 2022 it is speculated) from 20% to the top ordinary income rate – 37% now or 39.6% proposed – for individuals with more than $1 million income in a given year).

So, is it a good time to consider transitioning your busines or taking some ‘chips off the table’? That obviously depends on your specific circumstances. But is it worth considering the matter carefully at this time? For many the answer is “yes”.

© Copyright EdgePoint 2021. Russ Warren, Managing Director, EdgePoint can be reached at 216-342-5859 or at rwarren@edgepoint.com