When Christopher Rogers, member at Jennings Strouss Law Firm and president of the Association for Corporate Growth (ACG) Arizona, is out with friends and they ask about his legal practice, he says he works in mergers and acquisitions (M&A).
“When I was growing up and somebody mentioned M&A, I thought of Gordon Gekko in ‘Wall Street’ and these complicated, big deals. And sure, those happen, but M&A is a broad term that describes financial transactions that can encompass the sale of a family business for $200,000 or investments into early-stage companies. All deals aren’t like when Facebook bought Instagram,” he notes.
Even though they don’t always make the headlines of the Wall Street Journal, small to mid-size acquisitions are big business, according to Christine Nowaczyk, Arizona corporate banking executive for BOK Financial and chair elect of ACG Global’s board of directors.
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“Main Street companies represent a significant portion of the national economy and GDP (gross domestic product),” she says. “It’s these middle-market companies that rely on groups like ACG and its member professionals to be resources and help businesses grow by accessing capital or guiding owners through succession planning, whether it be a sale to employees, a third party or to private capital.”
Rogers describes the association as a nexus for people in the M&A space to network and foster a sense of community.
“We often think of those in the M&A field as just the investment bankers,” Rogers says. “But it takes all kinds. There are people who come from an insurance perspective, bankers who provide debt to finance transactions, brokers, accountants and lawyers. There’s this great mishmash of people in the M&A space and they all bring their own viewpoints and talents to help these things become possible. It’s where deals get done.”
Uncommon 2021
Last year brought a raft of changes. Vaccines that vastly reduce the lethality of COVID-19 became widely available for Americans. A new administration entered the White House. Businesses continued to struggle with supply chain issues as inflation rose to rates not seen since Ronald Reagan was president.
“People thought that once the pandemic started the M&A market was going to completely tank. From my experience, both professionally and anecdotally, that wasn’t the case. We still had a robust market,” Rogers notes.
Indeed, the business of selling businesses boomed, with 2021 recording historic levels of M&A activity. So why were businesses being bought up at an impressive rate? One cause was pent-up demand.
Rick Shapiro, president and CEO of The Wheatley Group, explains, “the 2021 uptick was driven partly by a backlog of deals that hit the pause button to ride out the uncertainty of 2020.”
Elise Thorpe, principal at Lovitt & Touché and past ACG Arizona president, agrees that initial pandemic-related closures led to deals being postponed until 2021, but adds that the coronavirus wasn’t the only reason for elevated M&A activity.
“There were concerns around changes to capital gains taxes,” Thorpe says. “Businesses owners wanted to avoid a big tax bill, which also helped spur the high levels of activity in 2021.”
Some business owners were calling Jim Afinowich, founding principal at IBG Fox & Fin, hoping to close a deal before the year’s end.
“If you look at the discussion about potential increase in capital gains taxes, it was upwards of 20%,” he says. “Imagine selling a business for $10 million. If you closed on January 1, $2 million more goes to taxes than if you closed the day before.”
Nowaczyk also observed a rush to exit over the last year and a half due to anticipated tax changes. On the other hand, Shapiro believes it was a minor factor.
“Taxes change depending on the administration in power. Sometimes they’re up, sometimes they’re down,” he says. “Regardless of the fact taxes may go up, private equity continues to do transactions and make acquisitions, notwithstanding the various challenges.”
The year ahead
Even if a backlog of demand and the specter of tax hikes spurred dealmaking in 2021, Shapiro notes that there’s still an abundance of dry powder in the market, or capital that needs to be deployed. “As a result,” he contends, “2022 could reach comparable levels as was manifested in 2021.”
This sentiment aligns with the results of ACG Global’s 2022 M&A Outlook Survey, which found that 80% of its members maintain a positive outlook for M&A activity in 2022.
Afinowich has heard the current market being described as “frothy” because of low interest rates and ample dry powder. He estimates there was $1.5 trillion of private equity looking for businesses before the pandemic, and now there is upwards of $2 trillion chasing deals.
“There’s more money out there to be invested than there are good investments to put the money in. That creates a very good market,” he says. It will take time to absorb that demand, which is why Afinowich thinks M&A activity will keep pace in 2022.
From Rogers’ perspective, he also sees signs of continued momentum.
“There may not be that same pent-up pressure this year as there was between 2020 and 2021, but you still have attractive valuations, which supports the willingness of business owners to look at selling their business,” Rogers explains. He adds that favorable economic indicators, such as low unemployment, a high performing stock market and the availability of cheap debt create a fertile environment for dealmaking in 2022.
Nowaczyk also believes that the market is going to continue to be strong, but the landscape is changing. “Investors realize that there’s a lot of overvaluation in the market, and I think people are hoping that it will normalize more in 2022,” she says.
The dry powder in the market and low interest rates are positive indicators, but Nowaczyk predicts that may change by the end of the year. “You’re going to have changes to the tax laws, interest rates will start to rise and you’ll see a change in valuations that will impact activity in 2022,” she says.
Time to retire?
With plenty of private equity looking to acquire companies, Arizona business owners can negotiate a deal from a position of strength. Thorpe mentions that she has multiple clients that are either on the buying end or are being purchased.
It’s a good time to sell, so long as the time is right for all stakeholders, according to Nowaczyk.
“What we’re seeing now is that owners are exiting the business because their valuation meets their expectation level or because it’s just the right the right time for them personally,” she says. “You have to realize that business owners generally only get one shot at this — and for most, the company represents their life’s work. A lot of people feel like now’s the right time.”
Shapiro echoes Nowaczyk’s sentiment: “There are lots of lenders looking to finance transactions and interest rates are still relatively low. There’s also an abundance of prospective buyers out there — whether you’re talking about private equity or strategic corporate buyers — looking to acquire smaller companies, where there might be synergistic value,” he says.
This doesn’t mean that every company will immediately be bought up should the owner choose to sell. An investor sees the acquisition of a business as an asset, and he or she will take time to evaluate their options.
“When you talk about money in private equity, those people are professional buyers. I was talking to a gentleman who runs a private equity company recently, and he said they look at 500 or 600 deals a year and close on three or four,” Afinowich explains. “My job is as much a matchmaker as it is a salesman — trying to find the right buyer to match with the right seller.”
Companies that are prime candidates to sell have certain characteristics that every buyer looks for. Afinowich notes that risk tolerances vary, and businesses with solid fundamentals and predictable earnings often get more offers.
“We typically go to market without a price on a business and run a gentlemanly auction process with buyers competing against each other. When they know there’s competition, they often pay substantially more,” he says.
A recent deal Afinowich worked on received bids ranging from $12 million to $18 million, with the latter amount winding up as the sale price. The owner mentioned that without a professional broker, he would’ve taken the initial $12 million offer, but instead secured a 50% increase.
Afinowich concludes that owners need to make preparations before looking for buyers. “It’s kind of like getting a house ready to sell,” he says. “You put a fresh coat of paint on it and clean it up.”
