Hart-Scott-Rodino Act

Smart Summary

• According to the lawyers at Kegler Brown and investment bankers at Copper Run Capital, 2021 will likely see a higher volume of deal activity, particularly for businesses and investors in the middle market.
• Businesses that weathered COVID-19 and adapted are likely to see increased valuations as investors look for proven business models.
• Policy changes in the Biden administration, particularly those affecting capital gains and corporate tax, will play a large part in deal structuring in 2021.
• Look for a concerted focus on distressed deals, alternative M+A models, and interest in businesses with strong ESG platforms as the economy continues to evolve.

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Throughout 2021, the client teams at Kegler Brown and Copper Run Capital are continuing to work with middle-market businesses as they navigate the changing landscape of a recovering post-COVID economy. We’ve gathered below the prevailing thoughts from these lawyers and investment bankers regarding the outlook for M+A in 2021. These and other tends are likely to set the guideposts for business owners, family offices, and corporate development pros, as the comprehensive M+A ecosystem adapts and evolves.

1. Continued Strength of M+A Markets

The View from the Lawyers
After grinding to a halt in Q2 of 2020, M+A markets experienced a remarkable bounce-back during the second half of the year, making up the vast majority of the lost deal volume from Q2. While it’s true that many of the deals that closed in late 2020 were motivated in large part by the concern over potential changes to tax laws under a Democratic-controlled government, we are optimistic that M+A activity will remain strong throughout 2021 due to a number of factors, including (1) strength in certain sectors, such as technology, logistics, and some manufacturing, (2) vast stockpiles of cash sitting idle and ready for investment, (3) banks that remain healthy and willing to lend, and (4) continued—and in some cases, accelerating—trends toward consolidation.

Areas projected to see significant M+A activity include (a) consumer goods, (b) energy and resources, (c) financial services, (d) life science and healthcare, (e) manufacturing, and (f) technology, media and telecommunications. We also anticipate companies increasing investment in technology. Executing deals virtually will continue to be a trend, and look for companies to invest in technology to help alleviate cybersecurity threats as a concern to the virtual deal-making environment and to ease post-closing integration.

The View from the Investment Bankers
Once deal activity resumed in the second half of 2020, the COVID-resistant business models and industries were busy transacting at near-normal market levels. While PPP lending in many cases caused delays in the transaction community, as clarity and comfortability around the forgiveness portion of PPP lending appeared, more deal activity picked up. Also to note, in several industries, we saw monthly financials begin to normalize in late summer, which helped bring a level of comfortability with performance. We expect this effect to accelerate into 2021 and bring about further deal activity.

We expect sentiment to continue to build and optimism to close deals increase while vaccines start to take hold. Investors have seen much of this optimism in the equity markets and that filters down through deal flow. We expect 2021 to be stronger, especially as Q1 and Q2 of 2020 were especially weak, and we don’t expect these types of quarters to be repeated this year, even if the vaccines take time to distribute.

2. Significant Impact on Valuation

The View from the Lawyers
Despite our worst fears, valuations generally held up well throughout 2020. Now, nearly a year into the pandemic, we expect to learn more about how valuations will be impacted in a post-COVID world during 2021. The interesting question will be how buyers view a post-COVID world and what impact that will have on valuations. We also expect to see some effect on valuations from anticipated changes in tax laws and regulations (see below), but we wouldn’t expect those to cause a major hit to valuations. Absent some major surprise—which we know is always a possibility, perhaps now more than ever—as long as there’s cash ready to be invested and banks ready to lend, we generally expect valuations to hold up well in 2021.

The View from the Investment Bankers
In the middle market, we still saw a lot of cash, especially from private equity funds, looking to find a home during COVID. These investors are paying up for growth, stability and responsive business models that weathered COVID. The first diligence question that seems to come up these days is “How did you do during COVID?” Companies with the right answer are easily seeing higher valuations. Sellers with more vulnerability have still been able to get deals done, albeit with bigger earn-outs and sometimes delayed closings.

With auction market volume down significantly during the height of COVID, private equity firms saw themselves clamoring over each other for the little bit of deal flow available in the market, which helped valuations and structures of those companies. Even with a strong uptick in auction deal flow, we expect valuation multiples to remain strong or even increase in 2021 given the supply of money flowing into the private markets to committed investment vehicles that need to spend the capital in a timely manner.

3. Policy Changes under the Biden Administration

The View from the Lawyers
While it’s unclear what exactly will happen and when it will happen—particularly with COVID relief and impeachment commanding Congress’ attention in the early days of the Biden administration—it’s clear that taxes are going to go up at some point, and Trump-era rollbacks on business regulation will be reversed, at least to some degree. For sellers, Biden’s proposals regarding capital gains taxes are probably the most alarming, and buyers have concern with the added costs of doing business in a more regulated environment. Though some businesses have hit pause while the situation unfolds in Washington, we expect most M+A activity to continue full speed ahead in 2021. Although retroactive tax legislation always remains a real possibility, many buyers and sellers are increasingly seeing that possibility as fairly remote in the current environment and believe that we may now have a window of opportunity before significant changes in tax laws take effect.

The View from the Investment Bankers
Tax rates are the broadest topic of concern regarding the new administration, with likely increases to capital gains taxes, as well as corporate taxes. In general, this may cause higher valuations and a higher volume of transactions in 2021 as the deal community learns more about potential tax changes in the future.

While many are estimating adverse tax impacts to sellers in the future, it will be interesting to see if that increase in taxes can be passed through to buyers in the form of higher valuations. This may likely be the case for sellers of attractive, growing companies facing the onslaught of weekly calls from buyers seeking a proprietary deal or those that go through a well-run auction process.

Also of note, likely increases in the corporate tax rate may have some impact on cash and financing available for acquisitions in the future, perhaps putting pressure on the M+A market past 2021.

4. Increasing Focus on Distressed Deals

The View from the Lawyers
While most of us expected a wave of distressed deals to hit in 2020, that fortunately didn’t materialize (for the most part). Government aid certainly helped, but more importantly, many businesses were able to pivot quickly to a new model that allowed them to stay afloat, or even thrive. However, as we approach the one-year anniversary of COVID, it’s sadly inevitable that more businesses are going to run out of lifelines. In particular, businesses in the hospitality and entertainment industries continue to get hit hard, and it’s not clear when things will actually get better. While the current situation threatens their short-term viability, many of these businesses still offer long-term value. Just as we saw in 2008-2010, there will be courageous and opportunistic buyers who will look to jump into the market for distressed deals.

The View from the Investment Bankers
Industries across the spectrum have felt the effects brought on by this pandemic – some more than others, such as retail, hospitality, and travel. After an initial wave of bankruptcy filings in Q2 of 2020, most expected that trend to continue throughout the year. Fortunately, as the dust settled, we saw companies adapt to their new environments and survive. However, a number of companies haven’t felt the true consequences of the downturn yet. Government stimulus and covenant compliance leniency by lenders helped companies weather the storm, but the long-term implications are still relatively unknown. Despite these obstacles, investors remain bullish with record amounts of unspent capital, particularly in the middle market. As a result, there could be a shift in focus toward identifying the less-competitive distressed opportunities that offer higher long-term value accretion.

5. Renewed Interest in ESG Deals

The View from the Lawyers
Although environmental, social and governance (ESG) have long been buzzwords in the business world, few businesses were doing much more than paying lip service to the concepts until recently. Today, ESG is no longer just an acronym with a mission statement; it’s essential that businesses have a meaningful and tangible approach to ESG. Customers and employees are demanding real commitment to ESG, and buyers will similarly put a premium on businesses with a strong ESG platform. ESG issues will also get much more focus in due diligence, which will require sellers to be proactive about not only implementing meaningful ESG programs, but proving their effectiveness.

The View from the Investment Bankers
ESG investing has been steadily rising for more than a decade, but has started exponentially increasing over the last few years. In 2021, this trend should continue as the Biden administration shows strong support for ESG initiatives, combined with a fundamental shift in consumer and investor behavior. One of the many driving forces of this change happens to be the COVID-19 pandemic, as people were impacted financially through non-financial risks. While it is almost impossible to prevent these non-financial risks from happening, there is growing sentiment for the ability to mitigate and manage these risks by transitioning toward a more sustainable and diverse economy.

6. Rise in Alternative / Non-Traditional M+A

The View from the Lawyers
We’ve seen a growing trend for several years in the world of alternative and non-traditional M+A, including structures like joint ventures, “mergers-of-equals,” partial investments and similar transactions. We expect that all of the uncertainty in the world will lead more businesses to adopt these types of strategies, which feature lower risk and upfront capital investment than traditional M+A deals. For many businesses, a transaction of this nature may offer an opportunity for growth that might not otherwise be available now, while also creating a platform for future transactions.

The View from the Investment Bankers
In an uncertain and cash-strapped environment like 2020, businesses and investors had to focus more resources on operations and portfolio management rather than growth. However, this did give rise to alternative M+A deals, such as joint ventures, minority investments, and special purpose acquisition companies (SPAC). Traditional M+A, or control acquisitions, remains the preferred model, but the benefits of alternative M+A deals are appealing and give businesses and investors additional options at their disposal, along with less risk and capital required.