November 3, 2020
M&A Heads to The Ballot Box: What this Election Means for Future M&A Activity
As the leading investment banking firm focused exclusively on high-end professional services and tech-enabled services businesses, Clearsight is dedicated to staying up-to-date on the concerns of the businesses within the sectors we serve. As we are all acutely aware, today’s election will have an impact on the public markets and M&A, whether through changes in policy or investor attitudes. In fact, we’ve been feeling the effects of today’s election for a while now, including the flurry of M&A activity starting at the end of the summer when firms were exploring liquidity events to avoid looming potential changes to long-term capital gains taxes. Capital gains tax changes, corporate outlook, and investor priorities are top-of-mind as we head to the polls and consider what the next four years will mean for the M&A markets.
The primary concern being discussed among business owners, their boards, and the financial sponsors who back high-end professional and tech-enabled services firms is what a change to long-term capital gains taxes could mean for a near-term liquidity event. Biden’s proposal includes a major increase to long-term capital gains taxation for individuals earning more than $1 million. Our recent infographic illustrates the impact the proposal would have on transaction proceeds. Our analysis concluded that business/valuation multiples would need to grow 30%+ under the new tax regime, compared to the same transaction today, for shareholders to receive a similar amount of net proceeds in a liquidity event. It’s best to keep in mind that there’s certainly no comprehensive tax proposal yet, and it remains to be seen how much of Biden’s campaign agenda will be implemented if he is elected.
If the Democratic Party gains control of the White House and Congress, then I believe we will see a huge amount of exits in 2021. Investors will look to monetize platforms and recognize capital gains in the hopes that new legislation increasing capital gains tax rates will not be retroactive, given that new legislation will likely need until at least the end of Q2 2021 to pass. If Trump wins reelection, the rate at which capital gains and other corporate taxes increase will most likely be slower, but the consensus is that corporate taxes will still go up in order to help pay for the trillions spent this year combatting COVID-19. Interestingly, the maximum capital gains tax rate has only increased once in the last ~30 years, with the 2012 American Taxpayer Relief Act. The Act increased the maximum capital gains tax rate to 20% and was not retroactive. However, as you dive deeper into U.S. legislative history, there are certainly many examples of retroactive tax increases, so it’s difficult to predict whether or not new legislation will be retroactive. I believe it will not be retroactive and the earliest that new capital gains taxes could come into effect would be 2022. The most important takeaway is that capital gains taxes only have one direction to go after essentially plateauing or decreasing for the last 30+ years. The change is coming, but how large of a change and the exact time period it will impact are still up for debate.
The second issue to consider heading into the election is the outcome’s anticipated effect on corporate and investor attitudes and, by extension, M&A volume. While many of the M&A market trends do not depend on the outcome of the election, the rate at which these trends unfold will absolutely be impacted by the election. This aligns with PwC’s latest Pulse Survey of 500+ US corporate leaders which found that changes to the US tax code are the top policy risk for businesses, regardless of who wins the election. The risk is heightened under a Biden administration but is still the primary policy risk under a Trump administration. Business leaders seem to agree that they are going to be the ones paying to offset at least some of the trillions of dollars spent by the US government this year to combat the COVID-19 pandemic. Corporate attitudes toward potential policy changes are critical when examining what the next four years will mean for M&A markets.
Additionally, corporate divestitures are likely to continue to trend upwards, especially if Biden is elected. We’ve already seen a rise in divestitures in 2020 and an acceleration of digitization and newly adopted forms of technology to power M&A processes, which is helping the M&A environment heat up heading into winter. The initial shock of the pandemic is certainly fading away, and as portfolio companies have spent months adapting to the ‘new normal,’ investors feel their portfolio company workforces are better prepared to handle any new surge in COVID-19 cases. The rise of corporate divestitures, including a couple of Clearsight transactions that closed in the past twelve months — Keane, Cumberland Consulting, and West Monroe Partners — are a result of C-suites evaluating assets they’ve been contemplating for some time and deciding to transact in order to become more focused on core assets as uncertainty continues into 2021.
No matter the outcome of today’s election, changes to tax policy and corporate outlook will continue to play a central role in M&A over the next four years. While the initial impacts of the election will differ based on the outcome, the direction of the markets is likely already set in motion. Should Biden win, we expect a rapid increase in M&A volume in the near-term that will likely taper once his new tax plan becomes effective. Alternatively, if Trump is reelected, we’d expect less volume of M&A in the next 12 months, but likely higher levels of deal volume in 2022 and beyond. We look forward to continuing all the exciting discussions we are having with boards, institutional investors, and founders/owners who provide professional and tech-enabled services.
To read more about the topics discussed in this blog and Clearsight’s Merchant Banking practice, check out Justin’s recent interview with Trivest Partners.
Vice President, Clearsight Advisors