The reference may be rather obtuse but the film buffs amongst you may attest to the fact that whilst the 1984 epic ‘Once Upon a Time in America’ was three hours and forty-nine minutes long, the investment was worth it in the end. The only movie I ever owned that required a swap of discs halfway through may be a fair analogy for the M&A market in recent months, with the duration of deals from initial offers to completion being far longer than one would hope.
I am by no means an economist, but there are obvious reasons for this, including amongst other things the continuing hangover from COVID, high inflation and associated interest rate hikes as well as reduced spending by the consumers due to the cost-of-living crisis. Clearly, some niche sectors have benefitted from these circumstances but for many businesses it has created uncertainty in the projected performance and allowed buyers the opportunity to approach purchases in a different way.
It is notable that buyers are structuring their offers in a much more cautious manner to reflect the uncertainty in the market at present. The use of deferred consideration and earn outs has increased as this de-risks the buyer and protects against paying over the odds if the business does not continue to trade as expected. We are also seeing instances where the delays in the progress of the deal have led to pre-completion price chipping based on the ongoing run rate of certain targets.
It is common knowledge that funds have the money to deploy but the willingness to invest has been quelled by the unrest in the economy. Trade buyers are also struggling to justify as many acquisitions as in past years. Currently, a more prudent approach may be being taken to bolster their own positions in the market through proven organic growth rather than a buy and build strategy using existing capital or additional debt.
So where does this leave the M&A market in the short-term? Well, to quote Yazz, ‘The Only Way Is Up’. Personal political views aside, the smart money has to be on a Conservative defeat at the next general election. Unless there is a monumental turnaround in public opinion in the coming months, it would seem likely that there will be a Labour Government in situ by early 2025 at the latest.
If history dictates the future, this is bound to lead to a degree of keenness from shareholders in owner-managed businesses to at least explore the possibility of realising the value of their companies. In the minds of most entrepreneurs, Labour equals an increase in Capital Gains Tax (CGT), which has often been predicted under the Conservatives but not recently come to fruition. However, even the Tories have been pressured into reducing certain reliefs to appease the masses so it would seemingly follow that, once in power, the people-pleasing first order of business from a tax perspective would be to increase this tax. Although it is commonly known that CGT is not as a significant cash generator as other taxes, this is a perception move.
There have been several threats of CGT increases in the past, which led to increased transaction volumes. However, none more in my tax lifetime bigger than in 2008 with the removal of Taper Relief, which meant certain disposals were subject to 10% CGT on unlimited gains rather than up to 40%. As this removal of relief was given a future date, the deal activity up to this deadline was unprecedented and encouraged the acceleration of many, many exits.
Although investment and acquisitions are still frequent and the market is not at a complete stand-still, perhaps the potential of a Labour Government will have a similar effect as it did all those years ago. Certainly, we are seeing increasing questions from clients as to what our opinion is on the likelihood of a CGT increase.
So, we are in a period of speculation and as the general election slowly approaches, and while we may not necessarily see the flurry of fast-paced deals we might expect, we do expect the transactional market in the coming months to reduce from their current double-disc marathon status.
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20 February 2024
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