After a quiet period set off by the coronavirus pandemic, private equity deal activity in the United States surged through mid-November as investment managers prepare for a possible tax policy change under President-elect Joe Biden. And the middle market has seen an uptick in deals.
Despite economic uncertainty, the prospect of higher taxes next year is helping push deals to completion.
The overall surge has been striking, with the number of U.S. and Canadian private equity deals escalating from a five-year low of 1,360 in April to 2,369 in October, according to Bloomberg.
November shows no signs of slowing. Through Nov. 17, 1,281 deals representing $158.9 billion of value had been completed, indicating another strong month. The onset of the pandemic in March created a once-in-a-century economic shock that firms are slowly crawling out of.
One reason for the sudden interest in completing deals – after months of a standoff as buyers and sellers could not agree on prices – is Biden’s intent to raise the corporate income tax rate from 21% to 28%.
Even with control of the Senate still undecided, the prospect of this tax increase favored by Biden has prompted many managers to close deals before any changes might take effect. Adding to the urgency is Biden’s support for raising taxes on capital gains, which could hamper dealmaking in the long term.
Activity has been strong not only in the middle market …
… but also in the smaller end of the market
Strength in the middle
But what distinguishes this recent increase is that it is taking place in the middle market – involving deals of $250 million or less. From 2015 to 2019, these middle market transactions represented no more than 12% of all M&A dollar value as the biggest transactions, driven by superfunds, characterized the market. But in 2020, middle market transactions of $250 million or less have grown to 16% of all M&A.
Part of the shift can be attributed to the continued economic uncertainty. Superfunds, after all, carry outsized influence in dealmaking, but in these uncertain times, firms are writing smaller checks. Economic fundamentals remain impaired, and it will be some time before a recovery restores the level of economic output to pre-pandemic levels.
The increase in activity is occurring even in the smaller end of the market, where transactions are for $100 million or less. Those deals have grown in proportion from 5% of all deals in 2015 to 9% in 2020.
According to Michael Fanelli, leader of the RSM Tri-State Transaction Advisory Services practice, this is the highest volume of M&A activity that the firm has seen over the past few months. The combination of deals being deferred because of the pandemic, along with the projected increase in taxes, has pushed a substantial amount of deal activity into the fourth quarter.
Generally speaking, the volume within the middle market and the lower middle market continues to be robust because of the number of businesses within this category, the number of private equity funds in the marketplace, and the consistency of M&A as a catalyst for growth within various industries.
At the beginning of the pandemic, we saw higher levels of technology and health care deals, but now in the latter half of the year, most, if not all, industries are seeing heightened M&A activity.
The possibility for sweeping tax policy reforms is no doubt a major driver in what we expect will be a frothy environment for M&A through the end of the year, but another reason is the favorable industry dynamics for private equity funds.
The takeaway
Historically low interest rates, record amounts of dry powder and ample distressed assets all play well for private equity in the long term. We expect many buying opportunities for well-priced companies. While the recent spike in COVID-19 cases may present a downside risk in the near term, the progress on developing vaccines announced recently should buoy dealmaking sentiment.
For more information on how the coronavirus is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
