Some mergers and acquisitions professionals are rushing to complete deals before the end of the year, ahead of likely tax rate increases next year.
In 2013, there will likely be a 5 percent or more increase in the capital gains tax rate that company owners would be subject to after selling a business, said Paul Griepentrog, an attorney in the M&A group at Godfrey & Kahn in Milwaukee.
The Patient Protection and Affordable Care Act would also tack on a 3.8 percent tax on net investment income next year, he said.
“I have about five or six (deals) that are early stages and trying to get closed before the end of the year,” Griepentrog said. “Now through the end of the year should be busy if the tax rate changes kind of remain what everybody thinks they will be.”
Steven Peterson, managing director at private equity firm Brass Ring Capital Inc. in Milwaukee, said this year was busy through the third quarter as businesses came to market with enough time to complete a sale.
Activity has slowed in the fourth quarter, but Peterson is still working on deals introduced in the third quarter, sweating a looming completion deadline.
“Right now, everyone’s doing this mad dash to the finish line to try to get it closed before the end of the year,” Peterson said. “I think investment bankers realized if they came to market after a certain date, it just wasn’t going to happen this year.”
Deals that are currently under letter of intent are rushing to close before the end of the year, said John Emory Jr., president and chief executive officer of investment banking firm Emory & Co. LLC in Milwaukee.
“A lot of people started the sale process in 2011 and early 2012 and closed successfully this summer and this fall,” Emory said. “We’re not scrambling too much right now because most of the year end deals have closed.”
Grant Thornton is still seeing some new deals coming to market with the outside hope of closing before 2013, said Jeff Bradford, a partner in the company’s Milwaukee M&A practice.
“The deals that we have in progress are on a fast track,” he said. “No one wants to leave anything to chance and getting your deal closed in 2012 is a top priority for those that have gone down the path.”
There is also some leverage with year-end deal completion, and many buyers were playing a game of chess with potential sellers, some M&A professionals say.
“We wanted to play out the deals as long as we could without jeopardizing our ability to do something and recognize the sellers’ need to do something by a certain date,” Peterson said.
The best advised business owners aren’t waiting until the last second to complete deals, since they lose negotiation power if a buyer can threaten to drag it out until January, Emory said.
“This is not a surprise. People have been expecting an increase in tax rates for the last several years,” he said. “Probably three of our closed transactions this year were motivated by getting ahead of expected tax increases.”
But Tom Kintis, president of CGK M&A Advisors in Waukesha, said he has not seen a huge sense of urgency to begin deals near year end.
“A lot of people, including myself, didn’t see anybody jumping up and down and saying, ‘Hey, we’ve got to do this and we’ve got to get a deal done because capital gains (rates are) going to go up next year,'” Kintis said.
Deal activity was about the same in 2012 as in 2011, with several deals getting started in the fall and aiming for a spring 2013 completion, he said.
Tax changes weren’t the only thing driving companies to market in 2012.
Corporate earnings are very strong in most industries, mainly because they cut costs during the Great Recession and revenue has come back in 2011 and 2012. That makes them attractive buys, Emory said.
Bank lending is up at lower rates for good companies, and there is a lot of dry powder waiting for the right time to buy, Kintis said.
“There’s just an incredible amount of money out there right now,” he said. “(Banks are) looking for the larger transaction because they’re looking for a little bit of a safety net on what they’re doing.”
Also, as retiring baby boomers look to sell, demographics will continue to drive deals going forward, Peterson said. The recession created some pent up demand from sellers.
Those that are able to sell in today’s market are seeing healthy EBITDA multiples.
“Sellers with good companies are getting just huge prices,” Peterson said. “Where we might have paid a five multiple for a deal in times past, we might have to pay a six multiple because the sellers demand it.”
There are a lot of factors contributing to higher valuations, Bradford said.
“You have a lot of private equity money chasing deals, you have a lot of corporations with strong balance sheets, so that creates competition for strong deals,” he said. “We’re seeing deal multiples and valuations that are quite robust.”
Milwaukee’s M&A activity has followed closely on the national trend, which follows the stock market, said David King, associate professor in the College of Business at Marquette University in Milwaukee.
“(Deal activity has) been down overall (this year), but it has increased in the manufacturing sector,” King said. “It’s very cyclical and it’s been down for three years, so it should increase.”
Milwaukee’s strong industrial sector has meant healthy levels of deal activity locally, he said.
Peterson expects M&A activity to stay strong and steady in 2013, since the election is over and business owners have a better idea of the political climate.
But the conclusion of the presidential election hasn’t totally eliminated uncertainty among potential sellers, so activity could lag a little in early 2013, Emory said.
“Since after the election, business owners are terrified by the fiscal cliff and want resolution to that before starting a process,” he said. “Not many people are starting processes right now because they have a lack of confidence – they want more certainty in the political landscape.”
Bradford anticipates a lull in the beginning of 2013, since there was such a rush to finish processes in 2012. But then business owners who waited through the recession for an exit and now have strong balance sheets and valuations are likely to go to market for the rest of the year.
“That’s going to pull businesses off the sidelines that have been waiting for a time to sell,” he said.
Investors are likely waiting for more certainty about taxes and economic outlook in the early part of 2013, Griepentrog said.
“We anticipate that the first quarter is probably going to be slow and then thereafter is really going to be wait and see,” he said. “Sellers may choose to defer a sale for a period of time where maybe their value’s a little bit higher so that the tax increase is not such a big change for them.” n
