A year ago, I predicted 2017 would see a robust M&A marketplace with climbing business confidence. It’s fair to say we’re there. Although we didn’t reach the record-breaking activity we saw in 2015, deal values and volumes remained strong.
Admittedly, I also predicted we’d have a new tax plan on the books long before now. It took a whole year to come to fruition, but now that it’s here we’re hearing a lot of enthusiasm from the M&A market.
We expect that tax cuts will encourage more owners to put their business on the market, now that the tax liability for selling your business has fallen. Lower than expected valuations are the biggest hurdle to getting deals done, but a sizeable tax cut could bridge the gap between what a seller wants to net out of a sale and what a buyer is offering.
Much discussion has focused on how the bill will help companies with foreign investments repatriate dollars for domestic investments. We also know that tax cuts will allow corporations to keep more of their earnings, giving them cash to reinvest in human capital, equipment, or acquisitions.
What’s less clear are how changes will impact leveraged buyouts. The bill limits the interest payments companies can deduct, which adds new risk while also making deals less lucrative.
But tax reforms aside, companies are already reporting higher cash reserves, and M&A is the number one intended use of those funds in 2018, according to an M&A forecast from Deloitte. Additional cash, in the form of tax savings, will only add fuel to the fire.
Not only are companies and private equity firms flush with cash, but they’re getting more creative about how they use it. Where these buyers once focused on the middle market, we’re seeing more activity move downstream.
As competition for quality deals increases, buyers are increasingly willing to invest time and capital into the lower middle market. We’re currently in talks, for example, with one private equity firm that did four platform deals last year and 20 add-on acquisitions. With add-on deals typically coming from the lower middle market, they’re stacking small acquisitions to reach their overall EBITDA targets.
We also know that multiple private equity firms just raised funds for minority purchases (less than controlling ownership). It’s an evolving strategy for firms looking for any way to stand out from the crowd of cash-rich buyers.
As for 2018, the M&A marketplace should be supported by continued business confidence, gradual increases in economic growth, and interest rates that will likely remain at historic lows. Even without tax cuts, we expected to see a solid market that favored lower middle market sellers. But now, the tax bill should bolster activity even further, driving both buyers and sellers to the table.