Lower middle market M&A saw a rapid recovery in the second half of 2020, and those trends are likely to continue in 2021. Many industry professionals are pointing to what could be a “banner year” for deal activity.
Here’s what’s going on in the market and what it means for business owners contemplating an exit:
Capital gains taxes likely to rise: President-elect Joe Biden has made it clear that capital gains taxes will rise under his presidency. That means business owners should shift their focus from total sale price to after-tax proceeds.
It seems likely the new administration will prioritize COVID-19 recovery in the near term. Analysts have suggested that tax changes are more likely to come later in 2021, with effective dates in 2022. Critically, Biden has proposed raising long-term capital gains tax to 39.6 percent on income above $1 million a year. That’s nearly double the current rate of 20 percent.
Using simplified calculations, if you had a $10 million company and paid capital gains at today’s rate, you’d net out $8 million. Now let’s say you work hard for three years, build your value to $12 million, and then sell under Biden’s new tax proposal. You’d net around $7.5 million.
With that proposal on the table, we believe we’ll see a lot of sellers coming to the marketplace. In 2020, it took us anywhere from four to 12 months to sell a lower middle market company. Business owners who want to sell ahead of (potential) tax changes don’t have a lot of time.
Business owners weigh fatigue against financial gain: For many business owners, the question of whether to exit their business is being driven by emotion and energy above financial takeaway.
COVID-19 has been an ordeal of epic proportions. Concerns about employee health and supply chain issues have business owners burned out, and we’re seeing an uptick in people who simply want to move on.
Volumes down, values held in 2020: M&A deal activity and values typically fall during a recession, but the COVID-19 pandemic created conditions that were anything but typical. Deal volumes fell in 2020, but supply and demand issues meant business valuations stayed close to industry peak.
It’s estimated that private equity alone has $1.5 trillion (not a typo) in dry powder. They need to put that money to work for their investors, and that’s helped keep valuations strong for COVID-resistant organizations.
In fact, pandemic-proof businesses actually fared better in 2020. The median multiple for lower middle market businesses that sold from Q1 to Q3 was higher than 2019, according to GF Data. The BizBuySell Insight Report shows Main Street businesses saw similar results, with the median sale price up 20 percent in Q3 over the year prior.
Buyers motivated from both sides of the coin: Businesses with strong balance sheets, including those sectors that saw a “COVID-windfall” (technology, grocery, home improvement, janitorial) may put those funds to use snapping up opportunities that will create long-term values.
Enterprises that were not as fortunate may still be looking to buy, searching for innovators who can help diversify revenue and create more COVID-friendly operation models.
For additional trends on the M&A market, Cornerstone Business Services is hosting a virtual State of M&A Conference February 24th. For more info go to www.cornerstone-business.com
About the Author
Cornerstone Business Services
Scott Bushkie is the managing partner/founder of Cornerstone Business Services, one of the Midwest’s largest boutique investment banks. He has more than 20 years in the industry, providing exit strategies, sell- and buy-side transitions, and valuation services in the lower middle market.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of Insight Publications, LLC.