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M&A TRENDS
INSIGHTS ON TODAY’S DEAL LANDSCAPE Despite the continuing pandemic, M&A activity has surged so far in 2021, with no immediate signs of slowing. Three M&A advisors shared their insights on the current deal landscape with Crain’s Content Studio. How is your organization involved in the M&A space? Joshua A. Klein: Our M&A team acts as a legal advisor for buyers, sellers, stakeholders and management in all types of acquisition and disposition transactions. We partner with our clients to evaluate their business needs and objectives and then assemble the right team to guide the transaction efficiently and skillfully to completion. We represent primary stakeholders in structuring, planning, negotiating and closing complex M&A transactions in public, private and cross-border settings. We provide our clients with a value-add solution by leveraging our industry knowledge with deep experience in asset and stock transactions, mergers, leveraged buyouts, recapitalizations, roll-ups, spin-offs, “going private” transactions and acquisitions of controlling, minority and strategic interests. John McNally: NFP has a primary role in three different aspects of M&A transactions. The first is pre-acquisition due diligence of the property and casualty and other operational insurance policies, employee benefits programs and retirement plans of acquisition target companies. We also de-risk M&A transactions with representation and warranty insurance (RWI), tax or contingent liability insurance, and directors and officers insurance on special purpose acquisition company (SPAC) deals, which raise capital through an IPO for the purpose
From our base here the Midwest, we maintain an M&A practice that’s truly national in scope. What’s the number one M&A question or concern you’re hearing from clients? McNally: The biggest concern from buyers has been the high level of competition for attractive assets, particular as we’re seeing the busiest M&A market ever following a lull in activity during Q2 and Q3 of 2020. The RWI market in particular has had to scramble to keep up with the volume of deal activity and some very short post-exclusivity periods during which to finalize diligence and place deal insurance. The large number of SPACs in the M&A market has also contributed to the increased competition. Doran: There are actually three, evenly-weighted concerns that we hear on a fairly consistent basis these days. The first concerns the impact of tax law changes; people wonder about the extent of any increase on capital gains taxes and when will this change become effective. The second concern is the continued uncertainty around the COVID pandemic, and its impact on supply chain and workforce constraints. The third concerns inflation and whether price increases are a temporary impact of imbalances caused by COVID, or whether a more systemic inflationary trend will take hold and bring with it a material rise in interest rates.
“MANY CLIENTS ASK HOW LONG THE TYPICAL M&A PROCESS TAKES AND WHETHER THE DEAL WILL CLOSE BEFORE THE CAPITAL GAINS TAX RATE RISES.” —JOSHUA A. KLEIN, NEAL GERBER EISENBERG of acquiring an existing operating company. Finally, we provide postclosing operational insurance, benefits programs and retirement plans for newly-acquired or merged companies, optimizing cost and quality over time. William E. Doran: Benesch’s corporate law practice is heavily involved in M&A in the middle market across a variety of industries. We represent corporate owners, entrepreneurs and family businesses, family offices and private equity investors. We have a robust private equity practice, representing a variety of committed funds as well as the independent sponsor community.
Klein: Many clients ask how long the typical M&A process takes and whether the deal will close before the capital gains tax rate rises. I closed a sale of a business last June, and we had many tax experts weighing in for the client regarding the political winds, including the likelihood that President Biden’s tax plan would make it through the Senate—because moderate Senators may not have the political capital to support it—and whether it could be retroactive to when the President first presented a general economic plan in April. It definitely pushed the parties to accelerate resolving certain issues to beat the clock.
WILLIAM E. DORAN
Partner Benesch wdoran@beneschlaw.com 312-212-4970
What effect has the COVID-19 pandemic had on M&A activity? Doran: In our experience, the pandemic has done little in terms of slowing the market. The private, middle-market M&A market has remained robust, while the resurgent public equity market and SPAC phenomenon has kept the public M&A market strong as well. We saw
JOSHUA A. KLEIN
JOHN MCNALLY
Partner Neal Gerber Eisenberg jklein@nge.com 312-269-8438
Managing Director M&A Risk Solutions Group NFP john.mcnally@nfp.com 203-940-3405
a short pause in activity in the second quarter of 2020, but ever since then we’ve seen a steady pace of interesting assignments as our clients have all remained active. Following the initial shock and slow down, the pace has been somewhat breathtaking, to be perfectly candid. The sharp rebound in market demand and economic activity in many sectors has fueled a very active M&A market that continues at a brisk pace. This
has created tons of work for M&A professionals in all sectors—from law to financial advisory to accounting to insurance and so on. McNally: Besides the more than 70% drop in deal volume in Q2 of 2020, the biggest impact of COVID-19 that we’ve experienced was the ability to perform due diligence and transact M&A deals on a largely remote basis. The ability to
“Benesch was extremely responsive at a critically important time as we were completing two platform investments. The fact that they have both transportation industry knowledge and a strong M&A practice really helps them understand the full set of issues and how they interconnect.” MARK FORNASIERO Managing Partner Clarendon Capital, LLC
MICHAEL RAUE Partner Clarendon Capital, LLC
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M&A TRENDS
INSIGHTS ON TODAY’S DEAL LANDSCAPE transact deals without extensive inperson management team meetings and physical inspection of plant, premises, and inventory pushed deal volume by Q4 of 2020 to greater than historic averages and 2021 has been the busiest year ever for the M&A insurance market. Klein: We’ve seen multiple effects on M&A transactions. For example, valuations of certain target businesses have risen due to positive impacts on sales tied to their product line becoming more popular with work-from-home dynamics and social and travel restrictions. We’ve seen similar effects with businesses having a connection to rapid testing technology or delivery systems. On the other hand, the inability to travel has slowed down some transactions where buyers required on-site confirmatory due diligence at sellers’ overseas plants, factories and the like. Have you experienced any busted deals as a result of COVID? Doran: Only one or two, and one was due to a business owner deciding to put the company’s sale on hold to focus on steering the business through the pandemic. The other was in an industry that was particularly hampered by the sudden lack of large, in-person meetings and events.
Klein: We had a deal that was put on ice and eventually terminated due to valuation concerns early in the pandemic, as well as frustration from the inability to conduct on-site due diligence at seller facilities. The seller believed in the true long-term value of his business, and was not going to accept a purchase price decrease for what he viewed as a temporary blip in terms of 2020 revenue. Instead, he moved on to operating his business until the right M&A opportunity came back to him, and we closed the sale of his business at his original value expectation in June 2021. McNally: We saw a number of transactions abandoned in Q2 and Q3 of 2020 in particular, but also this year—often post-letter of intent and pre-signing where the loss of revenue or other business impact of COVID-19 on the acquisition target caused a material change in implied valuation. We’ve also seen a few abandoned deals come back to life with the original parties completing deals several months later. Are you noticing trend differences between private equity/financial buyers and strategic buyers? Klein: It’s become the norm for financial buyers and sellers to expect rep and warranty insurance and, depending on whether the
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deal is through a broker auction in a competitive situation, minimal or no indemnification beyond the insurance. But we had to painstakingly convince a European strategic buyer that insurance is an excellent trend for buyers and sellers for various reasons. And strategic buyers also push for more cost sharing of the insurance, while financial buyers tend to quickly assume it as a buyer cost. McNally: From an insurance and due diligence perspective, we have not seen a particular divergence between private equity and strategic buyers over recent quarters. However, we’ve seen both doing more carveout acquisitions, and using RWI at historically high levels to de-risk their transactions.
Are you noticing any trends in buyers’ diligence? Doran: Due diligence has become an increasingly longer and more involved process. The trend began before COVID, due in part to the evolution of RWI, and continues as buyers seek to understand the potential mid- and long-term impacts of COVID on their target businesses. I also see an increasing use of a larger array of specialized outsourced diligence providers. Data security, state and local tax compliance and worker classification have also become more prominent topics of late. Klein: We’ve certainly seen an increasing focus on areas such as cybersecurity, insurance and anticorruption compliance. Buyers and deal insurance underwriters are also
buyers having lots of committed capital to deploy and find returns. The lower—less than $100 million in enterprise value—mid-market deal space has been extremely busy for us, including a high volume of platform add-on deals for private equity buyers, and carve-out deals for both private equity and strategic buyers. This is also a space where the increasing number of family office investors seems to have driven deal competition. Doran: There’s a tremendous amount of capital available that’s seeking to be put to work. We remain in a relatively low-interest-rate environment. The U.S. economy continues to be on a growth trend with sustainable growth prospects. Disruptive economic and societal changes, accelerated by COVID, are creating new business
“DUE DILIGENCE HAS BECOME AN INCREASINGLY LONGER AND MORE INVOLVED PROCESS.” —WILLIAM E. DORAN, BENESCH Doran: We’re seeing a greater willingness by strategic buyers to embrace RWI insurance and participate in broader auctions. Financial buyers continue to move much faster to closing, and RWI has accelerated this trend.
continuing to target compliance with employee classification rules and environmental concerns as key subject matters. And, though it’s not a trend, pre-closing tax matters are always a critical area for due diligence. McNally: The most notable buyer diligence trend has been far more frequent use of IT, data security and cyber liability specialists, and a specialist firm or consultant in addition to the law firm’s IT specialist team. We’re seeing this on most deals now, even small ones of less than $50 million in enterprise value. We’ve also heard reports about clients experiencing difficulty retaining advisors—particularly for quality of earnings reviews—given the increased M&A volume. What factors are currently driving middle-market deal activity? Klein: It felt like there was a shortterm COVID-induced pause in spring 2020 as companies focused on internal business issues as well as protecting valuation in the M&A conversation. But as soon as they navigated those rough waters, business owners looking for an exit came back to the market. And the excess “dry powder” of private equity capital looking for good middlemarket deals has been a driving force for years. So, while private equity capital investment took a COVID “time out,” it quickly returned to drive M&A over this past year. McNally: The biggest factor is pentup demand following the COVIDinduced lull in 2020, with strategic buyers looking to add complementary functions or capability, and financial
models, new operational models and new business opportunities. Baby boomers continue to shift toward business exits, while the millennials are entering their time of business leadership, high investment and consumer activity, creating demandside stimulus and transactional opportunities. How are family office investors impacting M&A? Klein: Family offices have become a formidable competitor to private equity funds in targeting M&A opportunities. And they have a different pitch to make to management beyond the sale price. The key differentiating factor ties to the typical management equity “rollover” where management buys and/or earns equity in the buyer vehicle for the business. A family office buyer can pitch management on their long-term approach versus a five- to seven-year exit path for PE. That approach is a better match for certain management teams, even if it pushes their next exit valuation opportunity further down the road. Doran: The family office has really come into its own over the last decade as a recognized and organized asset class. Many of these groups function with the equivalent activity of a small private equity fund or independent sponsor. The flexible investment mandate on terms and holding period is appealing to some sellers. This is creating even greater amounts of capital and competition in the M&A market. McNally: The increasing number of family office investors seems to be driving deal competition. The
impact in our book has been on lower mid-market deals, especially those below $50 million in enterprise value, and appears to have contributed to the increased level of competition in that segment. Family office investors are “professionalizing” a lot of these smaller deals, with more third-party advisors—legal, tax, financial, IT— being deployed akin to larger private equity deals. In light of the uptick in in cybersecurity breaches, how are you advising your clients regarding best practices? Doran: We are advising clients— especially those in retail or that touch customer or third-party data—to review internal compliance policies, procedures and standard operating procedures. Many businesses have ignored these risks, but none can afford to anymore. Klein: As it’s become such an important area of risk, information technology and cybersecurity are critical specialties for our deal team to offer clients in M&A transactions. To address this as a firm, we’ve added attorneys with this specific expertise over the past few years so that we can advise clients regarding all key subject matters in a typical deal. With our recent M&A deals, those members of our team, along with our insurance coverage experts, are leading the due diligence in those areas, assessing the applicable provisions of the acquisition agreement and advising the client on both the risk and how to mitigate it going forward. McNally: We recommend that buyers increase their focus on cyber liability insurance—both in terms of reviewing adequacy of existing target company coverage and any history of claims or breaches. We’ve also incorporated third-party data security consultants to enable a deep dive in our cyber liability insurance due diligence process. RWI insurers generally have an expectation of target companies having cyber liability insurance if full coverage of data security representations is expected, so having coverage in place has become a necessity on most deals.This has been complicated by an extreme hardening of the cyber market over the last 12 months, with price increases, higher policy retentions/deductibles and tighter coverage terms across all business segments and territories. How do you see the potential tax law and tax rate changes being considered in Congress impacting the deal market? McNally: It’s difficult to know with any certainty, but the potential
for increased capital gains taxes appears to have been a factor in the highest-ever deal volume we’ve seen throughout 2021, with Q3 the busiest yet. We expect a furious Q4 where efforts to complete deals will be very strong. On the other hand, we’ve seen some transactions stall on account of the uncertainty. In one instance, the buyer and seller agreed to split the cost of any additional taxes resulting from retroactive increase to the capital gains rate, allowing the transaction to proceed. We’ve also seen requests from both buyers and sellers to insure the risk of a retroactive capital gains rate increase. One insurer in the tax insurance market has been willing to offer this coverage. Doran: Concern with tax law changes has created some additional deal activity as sellers seek to lock in capital gains at current rates. However, based on the anticipated timing of upcoming tax changes, the period of “deals done under the wire” before rates increase may end up being fairly short. Klein: As I described earlier, uncertainty regarding details of the President’s tax plan and whether it will be approved are encouraging companies to take advantage now of current tax rates before they potentially rise. Where do you see the pace of transaction activity trending over the remainder of this year, six months from now, and for 2022? McNally: We expect the rest of Q3 and Q4 to be the busiest M&A market our team has ever seen, with no reason to believe that 2022 will slow down substantially. Deal teams have adjusted to the constraints of operating under COVID-19 restrictions, and concerns about potentially increased capital gains tax rates have not been featured in our discussions with investors. The large number of SPAC investors needing to complete deals should also help sustain larger mid-market and $1 billion-plus deals. Also, as most of our book is mid-market, increased antitrust/competition regulatory review should not be a substantial consideration. Doran: We believe that deal activity will remain extremely strong for the remainder of this year and most if not all of 2022. The factors are all in line for a continued strong market and level of deal activity. Rising tax and interest rates will dampen this over time, and there’s always the risk of another business disruption due to COVID or an unforeseen geopolitical event. However, we believe that the prospects for continued robust M&A
“WE EXPECT THE REST OF Q3 AND Q4 TO BE THE BUSIEST M&A MARKET OUR TEAM HAS EVER SEEN, WITH NO REASON TO BELIEVE THAT 2022 WILL SLOW DOWN SUBSTANTIALLY.” —JOHN MCNALLY, NFP
ABOUT THE PANELISTS WILLIAM E. DORAN is a partner at Benesch, an AmLaw 200 business law firm, where he specializes in mergers and acquisitions, general corporate and commercial transactions, private equity, and debt and equity finance. For over 30 years he has helped clients complete a variety of public and private transactions and navigate myriad business and legal challenges. He regularly provides responsive, thoughtful and effective advice to the leaders of business enterprises in a wide range of sizes and industries, often acting as the client’s principal legal counsel.
JOSHUA A. KLEIN is a partner at Neal Gerber Eisenberg, one of the largest single-office law firms in the nation, where he represents buyers and sellers in complex mergers and acquisitions involving middle-market and large businesses across numerous industries. He develops and implements comprehensive strategies for equity financing deals and reviews similar deals for private companies, family offices and high-net-worth individuals contemplating early and growth-stage investments. He has significant experience handling sophisticated venture capital transactions involving both lead investors and portfolio companies.
JOHN MCNALLY leads the M&A Risk Solutions Group at NFP, an insurance broker and consulting firm that provides employee benefits, specialized property and casualty, retirement and individual private client solutions. The group offers a full suite of insurance brokerage and advisory services for NFP’s private equity fund and corporate clients. A lawyer and 20-year industry veteran, he previously led the transaction advisory practice at JLT Specialty USA and before that held various roles at AIG and Beazley Group in New York and London.
activity will remain strong in the nearto mid-term. Klein: It will be interesting to see if the market will cool as the threat
of a capital gains tax hike becomes more likely in early 2022 along with rising interest rates and the cost of debt leverage. But the deal market has been so consistently hot for 13
months now that I could see it lasting at least through the remainder of 2021. I would even bet it will stay warm at least through the first half of 2022.
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