Private Equity Dealmaking is Breaking Records. But why Now?
Article Originally Published on Dallas Business Journal in July 2021. By: Catherine Leffert
The private equity merger and acquisition environment in North Texas has seen a flurry of activity so far this year, with high-dollar transactions and fast closings only part of the equation in the hottest deal market in decades.
The factors driving these deals – interest rates, tax concerns, the pandemic – are unsurprising
“I’ve probably been busier over the last 12 months than I’ve been my whole career,” said local sell-and-buy-side M&A lawyer Christina Marshall.
Data tells the same story across the country. This year is on track to be one of the most active M&A eras in recent history. An April Refinitiv report shows that the first quarter saw global M&A up 94 percent year-over-year and the highest year-to-date total since 1980. Ernst and Young reported the first quarter of 2021 marked the best quarter for private equity in the past decade.
The first two quarters of the year have yielded more than 3,700 deals worth over $456.6 billion in the United States, or almost two-thirds the amount in all of 2020, Pitchbook data showed. Dry powder is still near record highs – the same private equity database estimates about $703 billion sitting in American private equity funds as of the end of last year. Along with heaping capital on hand, Pitchbook said firms have raised about $179.6 billion so far this year, 70 percent of what they did in 2020 and a bit over half of 2019.
Boosted by a robust private equity ecosystem and a magnetic geographic region that’s pulling more business in by the day, North Texas is in on the M&A action.
But what are local dealmaking leaders seeing?
Low rates make debt easier and cheaper to obtain for borrowers, or in this case, the private equity firms. Between dry powder and easy borrowing, private equity firms have options for deals.
“Debt is so cheap right now,” said Edward Crawford, co-founder and president of DFW-based Coltala Holdings. “There’s a lot more debt than equity out there.”
Crawford added that he thinks firms should be careful of over-leveraging just because debt is accessible. Coltala Holdings has been active in the buying space, partnering with Dallas-based private equity firm Trive Capital to invest in a platform home health company and several add-on acquisitions since last summer.
Anytime interest rates are low, M&A activity will rise, said Colin Carter, a Dallas-based managing director for wealth management firm Tiedemann Advisors. He added people might rush deals because of the current unknown – how long will rates remain this low?
The Federal Reserve has held interest rates near zero to help stimulate the economy through the COVID-19 pandemic. The central bank recently estimated that rate hikes could come at the end of 2022 or early 2023, a timeline crunch from its original prediction.
Scott Fuzer, a Dallas-based senior partner and M&A leader at advisory firm West Monroe, also said that while deals spike anytime rates are brought down, he doesn’t see that as the defining factor in the M&A jump.
“Even if we see inflation and higher interest rates over the next one to two years, I’d be surprised if it has a significant impact on transactions,” Fuzer said. “At least for probably the next couple of years, we’re going to continue to see a pretty frothy M&A market.”
Another factor in a seller’s wheelhouse is President Joe Biden’s proposed capital gains tax changes. The Biden administration has publicly pitched an increase from the current federal rate of 20 percent to 39.6 percent for the highest wage earners. Though the hike might not come to fruition, and it might not be as high as double even if it does, sellers don’t want to miss the opportunity to exit with the lower tax rate.
Many local private equity leaders said they’ve interacted with sellers who are more eager to partner now because of potential capital gains tax changes down the line.
Trinity Hunt Partners Principal Garrett Greer thinks his private equity firm has likely been one of the most active in the North Texas market this year. Usually, Trinity Hunt looks to make two or three acquisitions per year, he said, but it has already announced three platform deals in 2021 – two of which involved rolling more than one company into a single platform.
Greer said the last 18 months are the best in the firm’s history, but he thinks potential tax changes influence some deal-making.
“There’s just a general belief that if taxes are going anywhere, it’s probably not down over the next year or two. It’s probably at least flat, if not up,” Greer said. “I think a lot of business owners can very quickly and easily kind of do the math along those lines and just say, ‘Well, gosh, if I’m thinking about selling in the next one to two or three years, how much more would I have to grow my business to offset that tax hike?”‘
Corbin Cook, co-founder and managing partner of Rise Run Capital, started his firm in January of this year, knowing that the potential tax changes would likely influence investment targets. He added he thinks the market is looking at an even higher influx of deals coming later in the year as more business owners decide they want to sell.
Align Capital Partners Co-founder and Managing Partner Rob Langley agrees.
ACP, co-headquartered in Dallas and Cleveland, has also been acquisitive over the past two years. During the first quarter of this year, ACP invested in one new platform and five add-ons, in addition to four new platforms and 19 add-ons in 2020. The firm also sold a platform company in its first exit since its 2016 inaugural fund. Dallas-based Langley said as the year goes on and the country gets closer to the potential capital gains tax increase, he expects deal-making to continue to climb. Pitchbook private equity analyst Rebecca Springer said the same in a note.
“The rest of 2021 will see this rush of deal-making continue, driven by the prospect of a capital-gains tax rate hike,” Springer wrote in June. “Although political negotiations are ongoing, its specter has undoubtedly set many sale processes in motion already.”
Langley said he thinks a spike could mirror past years when capital gains taxes were on the precipice of an increase, such as in 2012. However, in 2012, the M&A market had been relatively soft until the fourth quarter – unlike the current environment. But by the end of 2012, the time to either exit or pay higher capital gains taxes was approaching, and deals sprouted like weeds.
Local sell-side advisor and managing director at Founders Advisors, Neal England, said the potential capital gains tax increase is scary to sellers, especially ones whose businesses got rocked by COVID-19. Some sellers, especially owner-operators who are nearing retirement age, look for an easy out after a trying period, England said.
“If you’re in that age bracket of an entrepreneur, and you’ve even thought about selling and were surprised by COVID, then that will definitely have an impact on ‘how do I avoid the next downturn?”‘ England said. “That would fast track the thinking of anybody who remotely thought about selling, so they’d probably move that up on the calendar.”
COVID-19 revealed many companies’ weaknesses as it steamrolled specific industries and depressed the economy. When the pandemic first hit the United States in March, deal-making sank, and many firms had to put pins in investments. After Q2 of 2020, deals started to rebound and haven’t stopped since, M&A advisor Fuzer said. West Monroe has set a record for weekly deals almost every week since last July, he added. The past three quarters have been the three highest in deal activity in a decade, Pitchbook reported.
CIC Partners, a Dallas-based firm that invests across the food, restaurant, energy, industrial, infrastructure and health care industries, saw a boost in the deal flow, as well. Partner Amir Yoffe said in March that companies were more inclined to link with private equity because a firm could cushion security in liquidity, capital, succession planning and inorganic growth. Since October, CIC has announced four platform investments, a spate of rapid deals for the firm.
Some firm leaders and advisors also mentioned the impact of stimulus money and the Payment Protection Program loans on sellers. Langley from ACP said he thinks the most significant factor paving the way for the M&A environment is the $4 trillion the government spent in response to the pandemic.
As companies who were barely hanging on financially run out of government money, they’ll need a new strategy, which could involve selling to a private equity firm, Fuzer said.
“My belief is that these companies are going to probably start looking for assets, which means more inventory probably is going to be coming into the marketplace,” he said.” That inventory may be at a better price than what we’ve seen over the last at least three, four or five years.”
Crawford, of Coltala Holdings, said his firm’s pipeline of sellers is hot because of post-COVID-19 effects.
“We’re also seeing, on the seller’s side, a flight,” Crawford said.” People have gone through their PPP money. Many people have taken some cash off the table, and they’re saying, ‘These Biden tax cuts are changing. We’re going to go ahead and try to sell now.”‘
The pandemic not only poked holes in sellers’ weaknesses, but it also influenced buyers eager to do deals again, several firm partners said.
Marshall, the Dallas-based partner at law firm Haynes and Boones who focuses on M&A in private equity, said she’d seen a business ramp up rapidly in the last six months. She added that the types of deals she’s doing are more fluid – more earnouts, different ways to value companies and different securities.
“I think people have gotten very creative over the last year or year and a half,” Marshall said. “And all of the deals that I was working on when the pandemic started, I ended up closing.”
She added the environment is a seller’s market right now and that buyers are offering fair exit deals but making more concessions for targets. Fuzer agreed and said he’s seen sellers be pickier, bringing on more buyers and giving private equity firms less access to information – all on a faster timeline.
Local private equity firms predicted they’d continue to have an active year. Private equity firms tend to find a pace that works for them and stick to it, though the past 12 months have shown that isn’t always the case.
Still, how much longer will the conditions priming the M&A boom last?
“Anybody who knows the answer to that question will have a lot of money,” Langley said.
Though Langley said he thought the boom would continue until at least the end of this year, other local leaders had more specific predictions. Buy-side analyst Fuzer said he doesn’t see deal-making slowing down anytime soon, even if inflation and taxes change.
However, on the sell-side, England said he was more doubtful that the situation was tenable. He said if the right conditions turn up…maybe.
“There are lots of transactions that are occurring, but I don’t think it’s necessarily sustainable,” England said. “Could this be sustainable? Perhaps… Taxes aren’t as high as we think; employees get back to work, the stimulus gets eased back. I think we’ll continue to see a vibrant M&A market going forward.” Did you find this article useful? Why not subscribe to Dallas Business Journal for more articles?