What’s the outlook for M&A deal capacity by year’s end?

Are you wondering what will happen to merger and acquisition deals after the coming midterm elections? As a reminder, midyear was go-time for M&A activity. “Now is not the time to sit on the sidelines, but to reassess – even reset – M&A strategy,” PWC Global Deals Industries Leader Brian Levy said in a June 2022 report.

Yet uncertainty over how the midterms could affect policymaking is weighing on the minds of advisers pivotal to private equity deal strategy. The bad news first: We’re hearing that corporate tax professionals are under-resourced and ready to retire. 

What’s prompting these sage professionals to step away? A lack of talent, skill and technology to adequately meet unprecedented challenges is largely to blame, according to Thomson Reuters’ 2022 State of the Corporate Tax Department Report. Filling their shoes means ensuring that corporate tax professionals ages 41-50 stay in the workforce, the report says.

This younger cohort must be able to lead enterprise data analytics, conduct complex risk assessments and provide strategic intelligence critical to M&A strategy, due diligence and transition. The good news: Outsourced accounting and CFO services can help.

Tax treatment and modeling are best left to the experts. However, deal teams cognizant of potential tax-specific headwinds can tackle challenges and mitigate their impact on commercial objectives. We put together a high-level review on how Congress may change the tax code and what that could mean for M&A deal structuring in the future.  

Politics and M&A deals

Any change to the tax code may have implications for M&A transaction structuring, due diligence, negotiation and pricing. The 2017 Tax Cuts and Jobs Act contained several items that have impacted M&A deal structure from a tax perspective: 

• The corporate tax rate shrank from 37% to 21%, which, for example, improves the after-tax returns of “blocker” corporations.
• Net operating losses incurred after 2017 can be carried forward indefinitely and carrybacks are no longer allowed, impacting the acquisition structure to favor stock over asset transactions.
• The interest deduction is capped at the sum of business interest income plus 30% of earnings (generally calculated as EBITDA for four years and EBIT afterward). Interest not deducted can carry forward five years, which means buyers may prefer equity over debt financing for a deal.
• Certain depreciable property placed in service or acquired is 100% deductible, which could mean a total write-down of a target’s NOLs and no deduction benefit after the deal closes. 
• The 50% deduction of any Global Intangible Low Tax Income (GILTI) inclusion for certain C-corps until 2025 can positively and negatively affect stock sale for cross-border transactions. 

These are by no means a full picture of the provisions in the TCJA, but the tax code is no place for GPs. Let’s leave the deep tax cuts to the corporate tax experts.  

That said, we would be remiss to omit mention of the Inflation Reduction Act of 2022. Enacted mid-August, it ushers in a 15% corporate alternative minimum tax, which the Joint Committee on Taxation estimates will affect only 150 C-corps with an adjusted financial statement income of $1 billion. 

The measure passed in part due to a compromise eliminating a “carried interest” provision that would have required private equity funds to hold assets for five years rather than three to receive capital gains treatment. However, publicly traded companies may see a 1% excise tax on stock buybacks in 2026. 

Decarbonation incentives, emissions fees on methane gas and a better-funded IRS are other aspects of the Inflation Reduction Act that promise regulatory and compliance concerns for corporate tax teams. What’s more, the Act’s impact on future private equity dealmaking could be affected by the November midterms.

M&A dealmaking, post-midterms

Many private equity insiders are concerned about increased regulations that could overcomplicate deals. Given that every deal is unique, a portfolio’s CFO and tax specialists are poised to provide the best strategic insight on deal structure.

If you’re uncertain where to start the conversation, here are a few questions to ask about the current tax environment’s effect on M&A deals going forward:

1. What are the current tax opportunities for private equity?
2. What are the full tax implications for limited partners? Sellers? Buyers?
3. What are the tax advantages of stock versus asset transactions?
4. How do recent tax changes impact due diligence?
5. What’s needed from a tax perspective to close an M&A deal? 

Deal volume is expected to drop a bit for the year’s second half, with fewer IPOs, the challenge of agreeing on price in a volatile market, rising interest rates and inflation set to decelerate activity. But LPs want to see deals close, and the pressure to find alternatives to the IPO exit is on. 

Gatewood Capital Partners’ Michelle Jacobi told SS&C Intralinks that emerging managers are not slowing deal flow in the year’s second half. At least part of the urgency stems from LPs’ quest for investment and diversification. 

Time is of the essence, and it’s unkind to corporate tax accountants. Accounting and finance departments on both sides of the deal have lost a few good people to the Great Resignation. That means the buyer’s and seller’s corporate accounting and finance skeleton crew are stressed, just like 64% of 580 corporate tax professionals. 

The smart way to better deals is through outsourced accounting and CFO services. It’s also the best way to augment key financial functions — accounting software integrations, financial analysis, forecasting, reporting and board presentations — during due diligence and post-merger or acquisition when capacity is most critical. 

Want more? With Escalon, you’ll find that our business model is proven to meet the finance and accounting expertise gaps experienced by portfolio companies. Talk to an expert today.