M&A Buyers May Need to Move Quickly in 2021

One year ago, buyers were looking for talent. Every company we talked to was up against the same problem – there was so much opportunity to be had, but none of the employees to make it happen. It’s amazing how much can change in year.

Business buyers today are coming to the table for a host of reasons. The fortunate ones who benefitted from a “COVID-windfall” (e.g., tech, grocery, janitorial…and now, dry ice manufacturers) will be looking to capitalize on that success with acquisitions to drive long-term growth.

Other businesses who weren’t as fortunate may be looking for opportunities to add resilience and diversification in their business models. Innovators and technology leaders will be snapped up as buyers look for help pivoting in the COVID-19 economy.

And as uncertainty continues to upset consumer behaviors, some businesses will see acquisition as their most likely path to growth. When organizations can’t grow organically, acquisition becomes a means to get there, with the plus-side that economies of scale should drop a higher percentage of profits to the bottom line.

Here’s what’s going on in the market and what it means for organizations contemplating an acquisition:

Growing pool of M&A targets: In the United States, President Biden’s campaign tax plan included a sizable increase in the capital gains tax – nearly double today’s rate. While those plans may not come to full fruition, many sellers are entering the market now to get ahead of potential tax increases.

Those sellers, as well as businesses distressed by the pandemic, will create a growing pool of M&A targets. Analysts are predicting 2021 will be a banner year for M&A activity.

Seller urgency: A rush to complete deals by year-end 2021 (to get ahead of possible tax changes) means deal teams who have locked in their strategy and are prepared to act fast will have the advantage over buyer teams taking a more relaxed “we’ll know it when we see it” approach.

At the same time, seller urgency could provide a logistical challenge for deal teams who still haven’t returned to pre-pandemic due diligence habits. We’re still months out from widespread vaccination, and that means deal teams will need to rely on virtual processes for due diligence and negotiation.

Owner fatigue: When trying to hire new talent, recruiters reach out to passive job seekers, that is individuals who are employed and not looking for a job. The same dynamic can happen in M&A when a company launches an acquisition search. They reach out to “passive sellers” who are running their company and not on the open M&A market.

Right now, we’re getting a much stronger response to acquisition inquiries. Concerns about employee health and supply chain issues weighed heavily on business owners in 2020, and we’re seeing an uptick in people who simply want to move on.

Buyer competition: It’s estimated that private equity alone has $1.5 trillion in dry powder, aka cash they need to put to work for their investors. Private equity demand helped keep valuations strong in 2020, and should help us maintain a seller’s market in 2021, even if we see a boom in businesses coming to market.

And according to the PwC US Pulse Survey, 53% of US executives said their companies plan to increase M&A investment in 2021. The takeaway: If you’re planning to grow through acquisition, you won’t be the only one looking.

Valuations holding for COVID-proof businesses: There may be deals to be had for businesses distressed by the pandemic. But businesses unaffected by the pandemic, or those that bounced back quickly, are still selling near peak multiples – or even at a premium.

Banks have pulled back on lending just a bit, so buyers are filling out the capital stack with more of their own equity. We’re also seeing an increase in retained equity, in which the seller or their management team maintain a partial ownership stake in the new organization.

Likewise, we’re seeing an uptick in buyers who aren’t taking the full debt load available. By backing off on their leverage, they can keep themselves in a stronger financial position – just in case the pandemic would get worse yet before it gets better.

Jim Friesen, MBA, CPA, CMA, CM&AA

Partner | M&A Advisor