2020 began in innocence as a sellers’ market in the mergers and acquisition (M&A) space. Money and demand to do deals were readily available. When lockdowns began, the market did not stop altogether. Because deals take six to nine months to bring to completion, many of the deals that were in the works were completed. The deals that involved industries and businesses that were negatively affected by the pandemic may have been halted; however, the revenues of many businesses were not impacted severely by the pandemic. For these businesses, deals continued to be negotiated and completed.
However, while the number of deals decreased somewhat, multiples also tended to decrease due to the response of players in the M&A market to take on less risk. This was also true of those who financed the deals, such as banks and mezzanine lenders. This trend resulted in more earnouts and a greater proportion of the deal being seller financed as a way to bridge the gap between what the seller wanted to receive from the transaction and what the buyer was willing to pay.
Many of the clouds experienced during the dark days of the pandemic are starting to part. Here are six factors to take into consideration as to why now may be a good time to sell.
- The economy is expected to grow quite robustly in 2021. In its February 2021 report, An Overview of the Economic Outlook: 2021 to 2031, the Congressional Budget Office projects gross domestic product will grow by 5.6% in nominal terms without triggering inflation. In addition, the unemployment rate is forecasted to fall from 6.8% in 2020 to 5.3% in 2021. While these improvements are a rebound from a dismal 2020, they still present a strong backdrop for the M&A market.
- The industries that have been hurt are expected to rebound. While many businesses were not negatively affected by COVID-19 and some actually had improved performance, many industries were devastated. The probability of additional COVID relief, the distribution of vaccines, and a previously COVID exposed populous, will hopefully bring us back to normal. While it will take many of these businesses several years to recover fully, 2021 expects to be a year when things get closer, on a relative basis, to returning to normal.
- Valuation multiples did not decrease significantly during the pandemic. This situation may have been the result of negatively affected businesses pulling out of the market; however, it is expected that multiples will not fall and may increase slightly due to the amount of cash ready to be deployed. As has been the situation in past years, private equity money continues to look for a home. In addition, the expansion of the use of Special Purpose Acquisition Companies (SPACs) has resulted in still more money chasing private companies that are willing to consider sale.
- Financing is becoming more available. During the pandemic, senior lenders took a greater role in deal financing because other lenders pulled back due to heightened risk. While comprising a greater percentage of the financing piece of the purchase price, senior lenders were not immune to becoming more risk averse. Consequently, as stated above, earnouts and seller financing bridged the valuation gap. In addition, some private equity firms began using more equity financing with the thought of obtaining bank financing at a more opportune moment.
- The Federal Reserve has brought interest rates, yet again, to low levels. This condition reduces borrowing costs related to deal financing.
- President Biden has plans to raise taxes which would take a greater chunk of a seller’s proceeds. As a candidate, Biden proposed to increase the rate for individual long-term capital gains from 20% to 39.6%. That new rate for capital gains would apply only to taxpayers earning more than $1 million a year; however, with the sale a business, depending on the size of the business, some or much of the proceeds would be subject to this higher rate. One thing that seems certain is that taxes are going up.
If you are considering the possibility of selling your business, now may be a great time to do so. The team at MarksNelson stands ready to help you navigate the process, including whether to sell or not, preparing for sale, valuing the company, and more.