Expect an M&A frenzy in second half of 2021

This year started off fast, and it is only going to get faster. The Atlanta Federal Reserve in May reported GDP growth in the first quarter of approximately 6.4 percent which was possible in large part due to the euphoria of the vaccine rollout, ongoing government stimulus and the expectation that the cost of capital will remain at historically low rates seemingly forever.

Even though 2020 was not as bad as expected in much of the economy, it seems that everyone is trying to make up for lost time and operating at a frenetic pace in 2021. I have observed that private companies seem to be on or ahead of budget through the first four months of the year, and many public companies greatly exceeded earnings expectations and pushed the stock market to even greater heights. The Biden Administration has extended unemployment benefits and is promising even higher levels of spending by the government to support an economic recovery fully under way.

The combination of strong economic growth and the expected tax increases, particularly on capital gains, is setting the stage for a frenzy in the M&A market for the second half of 2021. Business owners who delayed selling in 2020 are determined to exit in 2021, and those who were thinking about selling in the next couple of years believe now is the time to sell before long-term capital gains tax rates increase dramatically. Based on current proposals by the Biden Administration, long-term capital gains could more than double from the current high end of 15 percent to be more in line with ordinary income rates, which at the high end are approximately 39.6 percent.

Once second quarter 2020 financials fall off the trailing 12-month calculation — because most businesses rebounded in Q3 2020 — many companies that want to sell will hit the market, trying to thread the needle between maximizing trailing 12-month performance after June 30 and any tax increases that take effect in January.

Targeted support for specific industries, specifically travel and entertainment, is clearly warranted because, even now, most are under some form of restrictions. These companies, many of them small businesses, are still hurting, and many will likely never come back. But I would argue that continuing the widespread government intervention that we all welcomed and needed in 2020 will have an increasingly negative effect on the normal functioning of our economy.

We are beginning to see signs of Alan Greenspan’s legendary euphemism “irrational exuberance” in many parts of the economy, including shortages in building supplies, computer processors and low-wage labor, and higher real estate prices, all of which historically have been harbingers of higher inflation. Further to this point, we also have new-fangled assets created out of thin air, like SPACs, Bitcoin, Dogecoin and NFTs (non-fungible tokens), which no one seems to be able to explain to me, as the newest path to wealth creation.

Maybe I am a bit of a traditionalist, and possibly a party pooper, but I have been around long enough to know when to look for the exits. They say don’t fight the Fed, but what if the Fed is fighting itself?

Jeffrey Kadlic is a founding partner at Evolution Capital Partners