Co-authored by Justin Shellaway, General Counsel of Hankook Tire America
On June 17-18, the Association for Corporate Growth (ACG) Kentucky and Tennessee chapters hosted the 12th Annual ACG Mid-South Capital Connection, bringing together over 200 private equity investors, mezzanine lenders, investment bankers, service providers, and corporate executives from across the Mid-South region.
Bass, Berry & Sims member and attorney Tatjana Paterno (Nashville, Tennessee) moderated a discussion of the current M&A climate and lessons drawn from recent activity. Offering their perspectives were the following panelists:
- Jay Burkhardt, Chief Strategy Officer of Probo Medical.
- Christopher Lewis, Managing Director of Greenwich Capital Group.
- John A. Mascarich, Managing Director of Baird Business Owner Solutions.
The following are some key takeaways from the discussion.
Current State of the M&A Market
Panelists agreed that the M&A market is enjoying an extremely high level of activity, with a significant number of deals being marketed and completed. Many service providers are at capacity and are either turning deals away or advising clients of longer lead times. The strength of the market was attributed to various factors, including the availability of financing, expected tax law changes, and availability of capital. The market strength is broad-based across all sectors, including healthcare, manufacturing, industrials, consumer, and business services sectors. Multiples are at an all-time high.
From the buyer’s perspective, the ability to grow and scale through acquisitions can be attractive and M&A is a way to deploy cash available on the balance sheet. Additionally, historically low debt costs have persisted and are expected to continue which allows deploying leverage to maximize return on investment. With a wealth of potential deals to consider, buyers are seeking businesses that expand the buyer’s capabilities, geographies, or customers. Diversified target companies are more attractive, as they better withstood the COVID-19 crisis.
Seller’s motivations are more diverse, but there are several principal factors. One of the biggest drivers appears to be the prospect of an increase in the capital gains tax. This has escalated pressure to complete transactions in 2021, before any changes take effect, resulting in especially aggressive timelines for completion. Not all sellers’ top priority is to receive the highest value possible. Though they have a target price based on their financial goals, some sellers are motivated to consider selling now by personal circumstances, such as family shocks resulting from COVID-19.
Meanwhile, sellers seeking the best price are trying to determine the ideal time to sell. Buyers’ and sellers’ expectations around valuations do not always match. This is particularly true now as buyers are looking at past performance and sellers see value based on future projections. This expectation gap can be bridged by various mechanisms such as holdbacks, escrows, and earnouts. Some sellers are waiting to sell until their businesses have fully recovered from the COVID-19 slowdown to receive full value.
How Deals Are Getting Done
The completion of some transactions has been delayed by the torrid pace of market activity. Dealmakers have never been busier, and in many cases are too busy to accept more work. “Clean and easy” deals get priority and get done quickly. Others that may have some complications or “stories” behind them may not get as much buyer attention, but even those types of deals are still getting done, though on longer timelines.
In particular, buyers are scrutinizing the pre-deal quality of earnings, calling upon their accounting firms more and conducting market studies. Serial buyers rely on representations and warranties insurance (RWI) and as a result, they have to document their diligence efforts more thoroughly to satisfy underwriters’ requirements. Nevertheless, for the most sought-after companies, power remains with the sellers; suitors are communicating from the outset their flexibility to accommodate those sellers’ idiosyncratic concerns or deal nuances.
The consensus was that the current M&A trend is expected to continue. Because of the crush of activity, deals that are not active in the market now are not likely to be completed this year and will likely roll into next year. Moreover, potential sellers who are poised to act once the economy recovers from COVID-19 could sustain the brisk pace of dealmaking for some time to come.
When asked to predict what could derail the very positive outlook for M&A, panelists speculated about an economic slowdown caused by inflation, which seems possible under current economic conditions. They also hypothesized that if the economy were to deteriorate and the fiscal supply was constricted, then all the leveraged transactions taking place could precipitate a credit crisis; but this was viewed as a remote “doomsday” scenario. The panel identified two immediate, more moderate headwinds. First, the U.S. dollar has depreciated across the world. Second, integration of companies is difficult because the labor force is stretched and aging – from production to middle management to leadership, the last of which is suffering the departure of the baby boomers.