“Elections have consequences,” President Obama famously told then Republican House Minority Whip Eric Cantor just days after taking office in 2009.
I run a Dallas-based middle market investment bank and my recent experience suggests that one important consequence of this year’s presidential election already has been its effects on U.S. middle market deal making.
What I’ve seen and observed in the market over the past 90 days:
• Uncertainty about the direction of future economic and tax policy is causing a rush by some business owners to close sale transactions before the end of the year.
• The rush to the exits is causing some market distortions and bottlenecks that likely will reverberate throughout 2013 and even beyond.
• The ultimate outcome of the election could well move the deal market significantly in 2013, though possibly in some surprising directions.
Keeping capital flowing to job-creating companies
The sales of middle market companies to strategic and private equity buyers helps keep the American economy dynamic and healthy by providing liquidity for entrepreneurs and investors in privately held companies. The availability of a ready mergers and acquisition market makes investors more willing to invest in start-ups and young growing companies – the kind that produce most of our job growth – because it gives them confidence that they can exit those investments smoothly and profitably.
While not nearly as high-profile as the “Barbarians at the Gate” world of Wall Street, middle market M&A creates huge amounts of liquidity in the American economy, with about $275 billion of middle market transactions closed in 2011.
This year, there’s a logjam of middle market deals, for these main reasons:
• Following sharp declines in 2008 and 2009, many businesses have put together two decent years of financial results, opening the window for higher valuations than were possible in the years immediately following the depths of the recession.
• Some entrepreneurs are worried that a second Obama term could spell additional economic turmoil and a less business-friendly climate than they’d face under a Romney presidency, potentially making this the most advantageous moment to sell a company for the next four years.
• Capital gains taxes, currently sitting at 15%, will jump to a top rate of 23.8% (as President Obama favors) for most prospective company sellers unless 2003 tax rate cuts are renewed – not likely if Obama is re-elected.
• Post-2008 regulations continue to make banks very conservative about “cash flow” lending, with very tight purse strings being applied to all but the most high-performing companies. Cash flow financing is needed by almost all private equity-led acquisitions, so difficult debt markets cause real dysfunction and delay.
Taken together, these factors have created a pig-in-a-python effect, with a large number of transactions all trying to fit through a pipeline that’s been constricted even further by the atrophy of four years of unusually light deal activity. As a result, some sellers are having trouble being heard above the din to move their transactions forward. Private equity firms find themselves inundated with solicitations for deals, causing them to react more slowly. Where we’d typically receive preliminary indications of interest from half or more of the potential buyers to whom we’d show a client company in previous years, this year with the bottlenecks that figure has dropped to about 33%.
Implications of Obama, Romney victories
We get paid to help sell companies, not to make political prognostications, but piecing together what I hear from clients and private equity investors suggests to me that an Obama victory could dampen M&A activity in 2013 because of higher taxes and a higher degree of business uncertainty, which generally leads to lower valuations. A Romney victory, on the other hand, could also slow the deal making pace by causing a sigh of relief on the business conditions front, persuading some companies to hold on and seek new growth in a revived economy. On the other hand, the lower capital gains taxes that a Romney presidency would bring would clearly prove a boon to the middle market and a more optimistic view of the economic future would likely push EBITDAacquisition multiples higher.
We’ll all have to wait for November for the answer.
Mike McGill is co-founder and managing director of MHT Partners, a Dallas investment bank.