M&A activity, already showing signs of a comeback after a long pandemic pause, could build to a crescendo in 2021 as private equity firms and owner-operators try to outrace any tax and regulatory changes the Biden administration is considering.

Although deal volume at the end of the third quarter was down 12% globally and 32% for deals involving U.S. companies, according to Refintive data, there are signs of a healthy pick-up in activity. 

"We've seen M&A volumes come back post-COVID," Scott Rhodes, managing director of Citizens M&A Advisory, said in a Frazier & Deeter webcast. "All of our transactions were paused during the heavy quarantine period, but the fundamentals remained solid. So, for Covid-durable businesses, all these processes restarted and are going well."

Kirkland & Ellis Partner Daniel Wolf told Bloomberg the pandemic has made organic growth difficult, so companies are looking for inorganic substitutes to attract investors. 

"Investors are rewarding growth," he said. "It's an active environment for M&A."

Company executives share that view. More than 70% of them responding to a survey by law firm Dykema Gossett said they expect the M&A market to strengthen over the next 12 months, up from 33% when they were surveyed last year. 

Tax impact

How much the Biden administration, with support from the Democratically controlled House and Senate, will impact dealmaking through tax law and regulatory changes isn't clear, deal specialists say. But the new administration has proposed raising the top corporate tax rate to 28% from 21%, a move that will make future deals more expensive right off the top. 

"Tax policy is going to be huge for M&A activity," Aaron Cutler, an attorney with Hogan Lovells, said in a Law360 report. 

Just as significant, at least for founders and owner-operators looking for an exit, is a proposal to treat long-term capital gains as regular income, which would tax gains from the sale of a business at 37% instead of 20%. After 2025, the 37% would rise to 39.6%, the same as before 2017.

"Certainly the owner-operators, in an M&A transaction, would be subject to an additional 17% tax on the sale of their business," LeighAnn Costley, a senior tax partner at Frazier & Deeter, said in a webcast. The additional 17% tax would result from the difference between the 20% capital gains tax and the 37% regular income rate. The change would only apply to sellers whose income is more than $1 million. 

Limited and general partners in a private equity firm wouldn't be impacted by the change, since they wouldn't be subject to the capital gains tax in that transaction.

"PE firms don't see a change in tax policy pulling forward any of their plans to exit their business," said Rhodes.

Even if the changes to the capital gains and corporate tax rates don't curb deal volume, they could still impact pricing, by pushing owner-operator sellers to seek higher valuations to offset the higher taxes.

"A business that was sold at 10x EBITDA would have to be sold for 13.2x EBITDA under the Biden plan to realize the same after-tax benefits," said Rhodes.

Window of opportunity

Given how Congress works and the competing priorities the Biden administration faces, there are few scenarios in which those and other tax law changes could take effect before early 2022, deal specialists say. That leaves 2021 as the year to get deals done if there's a concern over rising tax liabilities.

"If the Biden administration signals to us before the law is passed they don't plan for it to be retroactive, you'll see a rush to the exits," said Rhodes, "especially since we have some pent-up supply of companies that have thought about launching a [sale] process but have been on the sidelines with COVID and focused on their business performance."

Rhodes, whose company works mostly with sell-side businesses, said companies should start planning for a sale in the next few months so they can close before year-end.

"We will be encouraging prospective clients to start the planning process early," he said. "That first quarter period will be heavy prep so people are ready to take advantage of that window before it closes."

Antitrust focus

On the regulatory side, analysts don't see a major break from the previous administration in merger oversight, although the Biden administration would be expected to take a harder antitrust line. 

Look for "increased scrutiny of vertical and diagonal mergers, acquisitions of nascent competitors, [and] expansion by dominant firms into adjacent industries," a Dechert LLP analysis said.

The other area of heightened scrutiny would be on cross-border deals, especially with Chinese companies. The Biden administration is expected to maintain the previous administration's tough oversight of these deals on national security grounds.

"Scrutiny of Chinese takeovers of U.S. companies, which intensified under Trump, is expected to continue," Reuters reported. "In the last four years, the United States blocked many Chinese acquisitions, especially of U.S. technology firms, on national security grounds, and even ordered some Chinese firms, such as the owners of social media apps TikTok and Grindr, to divest them."

The Biden administration could also take a tougher stand on mergers within the healthcare space. 

"Biden has called for a retroactive review of recent mergers and acquisitions approved by the Trump administration in the healthcare sector," a Conner Strong analysis said. "Biden pledged to use antitrust authority to tackle market consolidation in healthcare (i.e., hospitals, provider groups, insurers, etc.) and scrutinize future acquisitions based on impacts on labor markets, low-income communities and racial equity, as well as prices and competition."