Private equity dealflow in North America is powering back, fueled in part by a potential corporate tax rate hike by the Biden administration, but inflation is emerging as a real risk.
“On the one hand, you’re seeing extremely high levels of ramped-up optimism. On the other hand… we are seeing signs of inflation now,” said a participant, speaking under the Chatham House rule. “It’s challenging, as a fund that’s investing, to find companies that are insulated” from inflation.
The panel featured private funds COOs and CCOs responsible for sourcing opportunities, either for the firm, portfolio companies or both.
“The market is as hot as it’s ever been in dealflow,” said one of the panelists, adding that the year to date in May was up 150 percent in activity, without citing a source for the number.
Another panelist reported that founder-owners are saying: “I’ll do a deal if I can get it done this year, because of increasing risk of tax hikes. It’s helped by a lot of capital and leverage being available.”
President Joe Biden’s Build Back Better program includes plans for corporate tax rates to rise to 28 percent from 21 percent. Senator Joe Manchin, a Democrat from West Virginia who holds a crucial vote in the Senate split 50-50 between Democrats and Republicans, opposes the rate but says he could support a 25 percent tax.
“It’ll be a substantial increase and there’ll be a lot of dealflow in the lower middle market… and motivated sellers,” a speaker on the panel said. “Valuations will go up next year in order to defray the tax burden [founder-owners] are going to be shouldering.”
Here comes inflation
The speakers agreed that inflation was real and spreading. “Number one, inflation is happening in labor. Any employee within 15 minutes of an Amazon facility is facing heavy competition” as the internet retail giant has set its minimum wage to $15 an hour, a panelist noted.
Inflation was manifesting elsewhere too, with shipping container costs to China surging and a shortage of truck drivers.
Unpicking the underlying performance of some potential acquisitions in a pandemic was proving tricky as well. “It’s really hard to get your arms around what’s real,” a panelist commented, citing a business that benefited “of course” from selling personal protective equipment but was now pivoting toward new customers.
Out of favor, in view of the panel, were companies in the oil business. “It’s not a great long-term play,” said one. “So many young folks look ahead and they’re making a very calculated decision now to move [out of oil] into a different sector.”