The Impact of Tax Reform on Middle Market M&A Activity

By Generational Equity


Recently, Mergers & Acquisitions Magazine published a piece examining the potential impact of 2017’s tax reform legislation on M&A activity. It is probably the most comprehensive overview I have seen so far and had some very relevant points for both sellers and buyers.

Overall, the writer suggests that 2018 M&A activity will be positively impacted by this legislation for two key reasons:

  1. The reduction of the corporate tax rate
  2. The repatriation of funds held overseas by corporations

Here are some excerpts of the salient points relating to this:

One of the most anticipated changes of the act included a reduction in the corporate tax rate from 35 percent to a flat 21 percent and the repeal of the corporate alternative minimum tax. Both will increase the after-tax profitability of corporations.

We have already seen that some corporations are using these extra savings as compensation incentives for employees but corporations will also be looking for making additional investments in the business, which sets the stage for M&A activity.

Based on our conversations with corporate buyers so far this year, we concur with this analysis, especially the segment I have bolded above. The significant profitability enhancement that corporations will see this year, as a result of this tax reform, will most likely spur a great deal of investment in areas such as R&D and employee incentives. However, acquisitions will probably play an even greater role.

The Impact of Tax Reform on Repatriation of Funds

Here is the point made in the piece on repatriation:

The act also includes a one-time repatriation tax on accumulated earnings held overseas. The repatriation of these funds by major corporations will likely be invested in one form or another to avoid additional taxes in the future.

This could set up a tremendous opportunity for the middle market because corporations may likely use their repatriated cash to acquire companies that complement their core business.

Again, like the corporate rate reduction, the act’s impact on freeing capital for investments will put the burden on acquirers to put that capital to work in the U.S. which may result in enhanced multiples.

There are two critical, related items found above. First, the best use of this cash coming back from overseas will be the addition of complementary companies to an organization’s business model.

Again, as we discussed in a prior article on how tax reform impacts M&A activity, the fastest, most efficient way to gain market share, new talent and new clients is via acquisitions. Repatriation will allow more of this.

Secondly, because the best use of this capital will be for acquisitions, a lack of quality targets may create a bidding war, raising business valuations overall. Although this remains to be seen, it is evident from what we experienced last year that valuations are creeping up, especially for well-run, profitable, growing middle market companies.

The Great Unknown for Tax Reform Legislation

This is great news if you are already in the midst of your exit plan and are in the market or going to be later this year. But, the article also points out the great unknown facing deal-making: the mid-term elections.

As of now, it is possible that Democrats could retake one, if not both, houses of Congress in this year’s election cycle. As we all witnessed from the coverage of the act’s passage, Democrats are not fans of this new legislation, which some have called a “corporate give-away.”

If Democrats become the majority, they might reverse the recently passed tax legislation, bringing back closer parity in individual vs. corporate tax rates.

Now this is a future event that is difficult to predict at this juncture. However, what it does imply is that if you want to take advantage of the tax reform’s benefits to our current seller’s market, you need to act sooner rather than later.

I have never heard a business owner lament that he started his exit plan too soon…. but I have heard dozens complain about how they waited too long.

Wise business owners are surveying the M&A landscape and are taking action now to hire an M&A advisory firm to guide them through the process of finding an optimal buyer, at the optimal time, for their company.

Start Your Exit Strategy with Generational Equity

Generational Equity is one of the leading lower middle market M&A firms in North America. If you would like to learn more about how our experienced advisors can help you, give us a call at 972-232-1121 or visit our website to leave us your contact information and we will be in touch.

If you would like to hear from a few of our clients about their decision-making process and how we helped them reach the next phase of their lives, follow these links:

And, to read the entire Mergers & Acquisitions article I am quoting from, please follow this link: Opinion: How tax reform will boost middle market M&A.

By Carl Doerksen, Director of Corporate Development at Generational Equity.

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