As forecast in our last two updates, M&A transaction activity has been increasing throughout 2021. Many business owners have been working to close a transaction before year-end and avoid the uncertainty of a new tax environment in 2022.

President Biden’s $1.75 trillion Build Back Better (BBB) Act may soon become law, bringing tax reforms with it, but many of the plan’s initial tax proposals were quashed the same day the bill was proposed. There are still tax increases on higher adjusted gross income and higher limits on SALT deductions, but from a 30,000 ft view of the proposed tax changes, it’s generally good news for owners of privately held companies contemplating a sale.

The best news for business owners selling a company in the new year is that the latest version of the BBB plan excludes increases for capital gains tax.  Business owners should have at least one more year to sell their business with capital gains tax rates at 20%.

Under the BBB plan, a business owner generating in excess of $10 million in income in a single year will still incur a 37% tax on adjusted gross income (AGI), but the BBB plan adds a surtax of 5% for these higher earners, and an additional 3% for someone making more than $25 million in a single year. The White House says it will also close certain loopholes that currently allow some taxpayers to avoid a 3.8% Medicare tax.  The largest US corporations will be subject to a minimum tax of 15% while companies with a large international footprint would have their foreign earnings taxed at a rate of 15%, an increase from the current 10.5% rate.  The bill is now in the Senate’s hands, where it is likely to be revised before being signed into law. Democrats need all 50 of their senators to vote for the bill, as Republican senators have voiced unanimous opposition to the BBB.

The White House has another problem to face next year with inflation eating away at all budgets. The late economist Milton Friedman wrote “inflation is taxation without legislation”. The pace of inflation hit a 31-year high of 6.2% in October and the Fed met early December to discuss, sharing guidance about their intent to taper purchases of bonds, reducing liquidity and opening the Fed to start raising rates as soon as the Spring. The Fed has been clear that future interest rate hikes won’t come before the tapering is complete.

 What else is on the horizon for M&A?

With most strategic and private equity acquirers wrapped up in due diligence and closing work through the end of the year, new acquisition opportunities will start hitting the market in mid-January. With only moderate proposed tax increases in the BBB plan, we foresee a continuing increase in business owners selling their companies, trying to get ahead of potential tax rates the following year and inflationary pressures leading to a rising rate environment and higher costs to finance an acquisition.

Business owners may be contemplating selling in any given year but are often motivated by a trigger event to take action and sell, responding to a prospective buyer or engaging an M&A advisory firm to guide them through the process.  As discussed in the research below, higher valuations are luring many business owners to sell, while potential for future tax increases and rising interest rates continue to create urgency for a sale. There is another contributing factor for those business owners approaching retirement. They have been waiting years for the right time to exit, they successfully navigated COVID and they don’t want to miss this opportunity.

The pipeline continues to be strong for new businesses coming to market. At ClearRidge, we have multiple new sell-side engagements launching in January. Analysts expect 2022 to be another strong year for M&A activity, with capital stacking up to be deployed.

In the section below, we consider the M&A outlook for several key industries in our region.

 Aerospace and Defense

With the US easing some travel restrictions, domestic and international commercial airlines recovering, pre-pandemic levels are predicted by 2023 or 2024.  While new COVID variants and outbreaks are still likely, the medium-term outlook for the aerospace industry is encouraging.  Boeing released it market outlook and industry forecast in September, projecting the global aerospace industry to reach $9 trillion over a ten-year period, their largest amount ever projected.

Our region has long been a stronghold for aerospace manufacturing and after a couple of challenging years, the future is brighter, and the M&A market is recovering. We anticipate a stronger 2022.

In terms of defense spending and consequential M&A activity, the Senate is still working to pass the Department of Defense budget, but the House and Senate, with bipartisan approval, have both recommended budgets higher than the White House proposal, suggesting that a healthy defense budget will be approved for 2022.  Defense capabilities such as digital transformation, simulation-based training, software development, security, and advanced weapons systems are of particular acquisition interest.

Chemicals

With an increase in manufacturing and construction activity, the Chemicals industry is experiencing rising demand across most segments. M&A activity is expected to remain strong throughout 2021 and into 2022.

Throughout the year, strategic buyers have sought deals that would mitigate future downturns through diversification of end market exposure, expansion of core businesses, and operational synergies. Carveouts of non-core assets have also bolstered M&A volume.

Deal activity has strongly rebounded in 2021 and is expected to continue, as the logistical disruption of raw materials is expected to normalize in the coming months.

Healthcare

Healthcare industry trends of digital, virtual healthcare and telehealth continue to accelerate, emphasizing the importance of IT infrastructure, security, and efficiency.  Healthcare companies with data management capabilities, particularly involving data collection, sharing, and analytics will be attractive M&A targets.

Hospital and Health System M&A transactions continued their trend for 2021, with fewer, but much larger transactions, increasing overall deal value.

M&A activity boomed for Home Care, Home Health, and Hospice due to higher valuations and a high volume of eager sellers.

Energy

Oil prices are expected to stay in their current price range, while natural gas prices are expected to increase due to rising demand and low storage levels.

Deal values decreased in Q3 but were still higher than the five year quarterly average for deal value.  Smaller asset deals are expected throughout the remainder of 2021 as companies right-size their portfolios and off load non-core assets.

Royal Dutch Shell announced its intention to divest all its interest in the Permian Basin to Conoco Phillips, reflecting Shell’s movement towards clean energy and Conoco’s interest in production expansion.

Private company transactions related to the energy sector have been depressed for a couple of years, but with recent higher energy prices, those companies that right sized effectively in a lower commodity price environment are now enjoying higher operating margins and are set for higher valuations with a sale in 2022.

Engineering and Construction

President Biden signed the long-talked about infrastructure bill into law, investing in the nation’s roads, bridges, broadband, water, and energy systems. The investment is expected to create jobs, in addition to improving the nation’s infrastructure.  M&A activity and acquisition interest is increasing in construction that serves the infrastructure sectors most likely to benefit from the bill.

High material costs, labor shortages, and supply chain issues remain headwinds for the construction industry.

For residential construction, there is a strong outlook for the fourth quarter with housing and building permits above Q3 2020 numbers. In August, housing permits were up 13.5% over August 2020.  The interest rate environment is one to watch closely for housing demand and home construction.

Industrial Manufacturing

Industrial manufacturing deal activity continued its strong trajectory in Q3. Industrial supplies and parts led in deal volume, followed by machinery and electrical equipment. The passage of the infrastructure bill will accelerate the upward trend and is contributing to a strong year end for industrial manufacturing M&A activity.

Labor shortage and supply chain disruption remain headwinds, with companies responding by securing temporary labor, building inventory and sourcing alternative vendors. Companies are also gaining efficiencies with lower head count.  Those that innovated and adapted with technology and diversified their supply networks gain additional attention among prospective acquirers.

Transportation and Logistics

Logistics remains the leading subsector in deal volume and value as the industry continues to grapple with supply chain disruption. The shipping bottleneck is expected to continue through the first half of 2022.

As with many sectors, Transportation and Logistics faces continued labor shortages with resulting higher labor costs. Younger generations find less appeal in transportation careers, also contributing to the shortage.

Sectors gaining attention among acquirers include electric vehicles and related suppliers, companies supporting ecommerce sales and last mile delivery solutions, even the drone market.

Plan Today

In order to execute a business sale in 2022, work should start before year end, with diligent planning and preparation critical to maximize the sale price of a company.  Our team at ClearRidge stands ready to clear all pre-emptive due diligence, research, identify and screen prospective buyers, create all confidential marketing materials, data analysis and memoranda, confidentially market the business, lead negotiations on price and terms, and manage the opposing counterparty’s diligence teams.

Sources: This report has been compiled from reports and research including federal data, independent analysis, Federal Reserve, Reuters, Janes Capital, US Chamber of Commerce, Oilprice.com, Kaufman Hall, DC Advisory, Kiplinger, PCE-Companies, Mergermarket, PricewaterhouseCoopers, and SDR Ventures.