M&A activity reached record levels in 2021, even as the fallout from COVID forced business owners to manage through inflation, as well as supply chain and labor issues. Despite these concerns, valuations went through the roof, in large part because of the high level of liquidity in the market and soaring public company market valuations.
“There's a lot of capital chasing acquisition opportunities," says Andy Vollmer, head of Bellmark Partners' Cleveland office. "There's typically an imbalance between the demand and liquidity for acquisitions on the buy-side compared to the supply of deals from the sell-side that generally always exists. I think at times it's exacerbated and that leads to exceptional valuations, and the valuations today are truly exceptional. They have clearly returned and even improved somewhat last year relative to the pre-COVID levels.”
Vollmer, a veteran of the M&A world with more than 30 years of investment banking experience and more than 100 M&A transactions, says the combination of exceptionally high valuation multiples and what’s needed to win a transaction in today’s disrupted market creates a lot of margin pressure.
“(It's) all the fallout from COVID, the supply-chain disruption, supply-chain delays, commodity inflation, container freight rates that have gone up quite a bit," he says. "Labor shortages are creating a lot of pressure for companies and it's also created, probably more so last year than this year in 2022, but certainly it created a level of uncertainty — from a buyer's perspective — about the forward performance and the projections of these businesses.”
As a result, buyers were looking for some security, which led to deal structuring in 2021 that increasingly relied on seller notes, seller equity rollover and earn-out provisions. Those provisions, however, may be a little less important in 2022.
“A lot of that uncertainty is starting to dissipate as we get into 2022,” Vollmer says. “But there's definitely, as a result of the high valuations and just everything that was going on in the economy and all the disruption related to COVID, a lot more reliance on deal structure in order to achieve those high valuation metrics.”
One of the major drivers for activity in Q3 was possible increases in the capital gains tax. Vollmer’s not sure that’s as much of a concern today.
"There was substantial tax-motivated selling in ’21 trying to get ahead of prospective increases in capital gains taxes,” Vollmer says. “Where those tax increases are now, who knows? But I think the market is certainly less concerned about tax increases now than they were six, nine months ago.”
Looking forward, Vollmer believes segments of M&A that were hurt by COVID, such as traditional restaurants, and brick-and-mortar retail, will continue to bounce back. In addition, he expects business, consumer, and technology services, as well as health care, to remain strong markets in M&A, and there should be more activity in the industrial segment.
“Not that the industrial segment was dead last year, it wasn't,” Vollmer says. “But certainly in the middle market there was a lot less industrial M&A volume than what we had normally seen. We think a lot of that will come back this year and we think a lot of those companies are the ones I was alluding to earlier — those would-be sellers that have decided to hold off because they're dealing with margin pressures with their business from supply chain disruption, inflation labor shortages, etc.”
Vollmer spoke on the Smart Business Dealmakers Podcast about the record-level of M&A activity in 2021, the driving factors of that activity, the consequences, and what we can expect for the remainder of 2022. Hit play on the podcast above to catch the full conversation.