Current Trends in U.S. M&A and Private Equity Investments

Geoffrey R. Morgan, Founding Partner, Croke Fairchild Morgan & Beres

In the United States, a rise in vaccination rates, falling unemployment and continued economic recovery have spurred a level of confidence not realized since before the onset of COVID-19. And that confidence is fueling substantial activity on the private equity and M&A fronts. According to PitchBook, PE firms in the U.S. closed more than 3,700 deals valuing a combined $450 billion in the first half of 2021, with the second quarter recording one of the highest levels of deal activity in the past 10 years.

The surge in both confidence and deal-making activity has caused a spike in valuations across multiple sectors, a trend that shows no signs of reversing. For investors in Europe and other parts of the world that may have been eyeing U.S.-based targets, this may be an opportune time to pursue investments.

The following trends and insights may be helpful for European PE firms considering the purchase of or investment in a U.S. company.

Target Evaluation Methods are Evolving, but Face-to-Face (or Zoom) Connections Provide an Edge

Several factors contribute to how private equity firms evaluate U.S. companies, particularly when the investors are abroad. Technology- and AI-powered data platforms can provide critical insights to international investors, enabling them to better assess market position, the efficacy of management teams, and other key areas of growth and operations. Unfortunately, most firms have access to the same data, so the insights alone are insufficient. Additionally, with so many nontraditional investors joining the ranks of ownership in U.S. companies over the past decade, more due diligence than ever before is needed.

One way to ensure productive, 360-degree evaluation is to require face-to-face (or Zoom) meetings and, where possible, in-person discussions as part of the target evaluation process. Data can only take investors so far. In-depth and ongoing conversations about goals, objectives and the company’s growth trajectory is one of the most powerful evaluation tools. Don’t let geography be a deterrent for making sure this happens.

The U.S. Employment Landscape is Causing Delays

Right now, in the U.S., employment and staffing issues across hospitality, retail, manufacturing, and other sectors are straining supply chains and keeping businesses from operating at full capacity. According to the U.S. Bureau of Labor Statistics, unemployment in August 2021 was 5.2 percent, significantly higher than the pre-pandemic unemployment rate of 3.5 percent. While federal Covid-related unemployment benefits have expired, and more Americans head back to work, companies across the country are still feeling the effects of staffing shortages.

Financial institutions and other service providers are among the companies impacted by labor shortages. A tighter workforce has slowed the pace at which deals and transactions are processed and closed, and companies providing ancillary services such as due diligence are also having trouble keeping pace with the record number of transactions. PE firms abroad should account for employment-related delays in their timelines for acquiring or investing in U.S. companies.

Proposed Capital Gains Increases Weigh Heavy

Earlier this year, U.S. President Joe Biden proposed raising the capital gains tax from 20 percent to 39.6 percent, which would effectively double the tax on investors that profit more than $1 million annually from the sale of investments. In September, House democrats proposed a maximum capital gains tax of roughly to 28 percent. While no agreement has been reached to date – and final rates could be negotiated down – the ongoing discussions are beginning to spur a rush of exits as private equity investors look to safeguard their returns.

On the other hand, the Federal Reserve has signaled it is considering a rate increase in 2023. While much could change between now and then, historically low interest rates and significant exit activity still make Q4 a potentially profitable time to move on a U.S. target.

The U.S. is Catching Up on ESG

Over the past 18 months, environmental, social, and governance (ESG) and diversity, equity, and inclusion (ESG) initiatives in U.S.-based companies have moved beyond a check-the-box approach. Chief Diversity Officers have emerged as the latest and most prevalent addition to the C-Suite, and corporate leadership and boards of directors largely recognize the value of ESG and DE&I from both competitive and operational perspectives.

Just as investors look for evidence of ESG commitments in their acquisition and investment targets, private equity firms should also begin to expect U.S. companies to require evidence of the ESG commitments held by potential partners. As the face of the company to its U.S. customer base, they will be required to answer – often in real time via social media – for the values, beliefs, and practices of investing companies. If your commitments make that an easy conversation, you’ll enter negotiations a step ahead.

Not All Industries are Created Equal

The COVID-19 pandemic has drastically changed how investors evaluate not just companies, but entire industries. In today’s U.S. economy, identifying opportunities that are scalable has significant upside for private equity investors. Technology, food and beverage, healthcare and business services are seeing the highest multiples and greatest returns. While valuations have spiked in industries providing pandemic-related goods and services (i.e., healthcare, PPE, etc.), there is no evidence to suggest those valuations won’t hold over the next 12-18 months.

Of course, industries hit hardest by the pandemic, namely hospitality, travel, and real estate development, offer investors a rare opportunity to buy at below-market prices and, potentially, realize significant returns as the economy recovers. And new industries based on consumer behavior during the pandemic (i.e., home renovation and crafting) are emerging as valuable investment opportunities, too. Still, scalability remains among the most important characteristics of a company for investors; if a target can’t demonstrate the capacity to scale with demand (or scale back if demand weans), it could be a red flag.

The SPAC Space is Changing

Special Purpose Acquisition Companies (SPACs) emerged in 2020 as a desirable vehicle for investors buying into startups as well as for PE exits. SPAC activity has slowed substantially in recent quarters, in part because the U.S. Securities and Exchange Commission has imposed additional disclosures and procedures whose absence made SPACs an attractive prospect to investors and targets alike. Still, there is every reason to believe SPACs will remain a permanent fixture in the years ahead.

SPACs can be incredibly attractive for private equity investors, though understanding the SPACs goals and target company’s financials and potential require significantly more due diligence. The most successful U.S. SPACs are those with a disciplined management team, whose target criteria is aligned with the experience and expertise of its management team, and whose fellow investors have been well vetted.

There are many reasons for global private equity firms to consider investments in U.S. companies. Historically low interest rates, an abundance of capital and a continued economic recovery have paved the way for another significant year for private equity in the United States. But it’s important that European PE investors have the knowledge to capitalize on the opportunities while they exist.

Geoffrey R. Morgan is the founding partner of Croke Fairchild Morgan & Beres in Chicago where he provides strategic guidance to growth-stage startups and Fortune 500 companies in areas of transactional law with a focus on corporate finance, M&A, corporate governance, and securities regulation.