What is driving growth in the M&A market in the UK?

Following a busy year for mergers and acquisitions (M&A) activity in 2021, Business Leader looks at what is driving this growth and what the future holds for the sector. In this feature, experts operating in the space also explain what leaders need to know about changes in legislation, run the rule over international investment into the UK, and also share their tips for what you need to know when preparing to sell your business; and what it is really like to go through the process.

What were the key trends that shaped 2021 M&A activity?

Mark Clephan, Head of North Corporate Finance at EY: “2021 began in a flurry, as private business owners raced to complete deals before the Chancellors Budget and potential Capital Gains Tax change – although this did not materialise. The remainder of the year saw high prices, together with elevated levels of activity, leading to many advisers being sold out, record levels of IPOs, and overseas trade and private equity activity. Key trends including sustainability and ESG, have become an increasingly important aspect of dealmaking.”

Jim Shaw, CEO of Shaw & Co: “In terms of 2021, the market was certainly volatile, with plenty of activity driven, unsurprisingly, by the pandemic, which has seen so many businesses having to transform their whole business models. The technology sector continued to be a fertile space for acquisitions, as larger companies sought to plug the gaps in their offering that had been exposed over the last 18 months. Furthermore, with debt remaining extraordinarily cheap, larger corporates themselves had a huge incentive to acquire good businesses of all sizes, as they quickly tried to adapt their business models to the changing market.”

Ivan Sedgwick, Investment Director at LGB: “Global M&A had its biggest year ever at $5.7tn, vs $3-4tn between 2014-2020. The big drivers were TMT ($1.8tn, double the previous peak) of which tech alone was over $1tn; healthcare (up 67%) plus a resumption of activity in traditional sectors as we got used to Covid-19.

“Though they garnered headlines, SPACs were a little over 10% of activity but peaked in Q1 and were almost entirely a US phenomenon so not the major driver. However, private equity was important, with buyouts at a new high of 27% of all M&A activity from 20% in 2020.”

Ewan MacKinnon, Partner at Maven Capital Partners: “Covid-19 has continued to exert influence, sustaining the focus on tech-enabled companies that we saw in 2020, and many corporates used M&A in 2021 to acquire technological capabilities they did not previously have.

“Aside from this, there has been a significant increase in the use of SPACs and heightened focus on ESG considerations among both investors and investee companies, as the business community drives towards its net-zero goal.”

What are your projections for M&A activity in 2022 and beyond?

Fraser Thorne, Chief Executive at Edison Group: “Given the record year we have had over the last 12 months, we don’t expect to see an increase in the number of deals we secure in 2022. However, we are likely to see other sectors apart from technology and healthcare move to the forefront.”

Mark Clephan: “External macro factors which could significantly influence the deals market remain, including Covid-19 and ongoing global supply chain strains. They are likely to reduce confidence in certain sectors, impacting M&A activity.

“Recently we have seen evidence of a shift to a new cycle of dealmaking, following the immediate reaction to the pandemic, into a more considered phase as companies review all areas of their business strategy and look to get fit for the future.”

Jim Shaw: “In general, this is a positive environment for dealmaking in the right sectors, and will remain so for the next twelve months at least; with interest rates expected to stay low and the corporates keen to invest balance sheet funds, and private equity dry powder being eagerly invested against fixed fund timelines.

“In general, the pandemic did not dent M&A activity and if anything, there appears to be a pent-up demand. We just need the Chancellor to be fair on Capital Gains Tax, lest we see scores of UK business being run by entrepreneurs sat on beaches thousands of miles away.”

Ivan Sedgwick: “Cheap money does not guarantee a continuation of the boom. Liquidity is like air: there is the same amount whether the wind is blowing or not. If we are faced with uncertainties – whether from increasing energy prices, conflict in Eastern Europe or the South China Sea, or a rise in interest rates – we could certainly see a slowdown of activity. Managements can always delay bidding, even if bankers try to persuade them that their potential targets will be lost forever.”

Ewan MacKinnon: “There will be a buoyancy about 2022, with plenty of private equity firepower waiting to be deployed. Moreover, as we hopefully emerge from the pandemic this year, the UK’s economic fundamentals should keep improving, which will encourage more activity. At the same time, companies will need to address ongoing issues such as supply chain shortages, labour shortages, and wage inflation.”

What advice would you give to a business leader looking to sale their business? How can they best prepare for sale?

Jim Shaw: “The most important thing is never, ever, sell your business without seeking the advice of a qualified, experienced, corporate finance advisor. I know, you would expect me to say that but there is too much on the line to be learning on the job or entrusting anyone other than absolute expert. If you do then you will certainly regret it. I can think of several recent deals where we have doubled (or more) an initial, unadvised, offer.

“If you have a good business and are looking to sell then you must be confident, assured and patient enough to decline that first offer. One of the greatest tools at your disposal is the chance to create a ‘Fear Of Missing Out’ amongst potential buyers, persuading them that this is a huge opportunity that simply cannot be missed.

“A good advisor will start by packaging up your business and making it as attractive as possible to a range of potential buyers. This takes a level of analysis and real marketing skill which few advisors possess.”

Ewan MacKinnon: “Prepare, prepare, prepare. You will need to start getting your house in order months before starting the sales process, and this should include succession planning if you intend to leave following the sale.

“Expertise is essential. A strong financial controller within the company will be able to analyse the historics and assemble the financial projections that buyers want to see. In addition, a good corporate finance advisor can help secure the best price for your business, while a good corporate lawyer will handle the M&A negotiations competently.”

And how stressful is the process? How would you describe it to somebody that hasn’t been through it?

Jim Shaw: “Sometimes negotiations get tense. A big part of our job as financial advisers is being the barrier that absorbs that emotion and keeps a deal on track. For an owner-manager in particular, deal negotiations can quickly feel personal. Removing yourself from this is one of many significant benefits of appointing a professional advisor to negotiate your deal.

“Business has changed over the years so even ‘fraught’ negotiations are nothing like the big public company hostile takeovers of yore. Nevertheless, there’s a lot of hard work and hard data involved in securing a sale, but it’s also an art, a craft if you will. The reality is that each deal, business, and owner is different.

“Deal craft also involves focussing on the common goals between parties, in order to find a way through any impasse. Understanding the points that really matter and the points on which compromise can be reached takes experience and foresight. Like a good game of chess, you have to be able to think four or five or more moves ahead.

“To be able to do that takes a huge amount of deal experience; if you find yourself reacting to what is in front of you without fully understanding the consequences of your next move, you are likely to come up short against an experienced player.”

Ewan MacKinnon: “Having been through it twice myself, I know first-hand that the process can be stressful, which is perhaps unsurprising given that you essentially end up working two jobs for the duration of the sales process. Preparing all the information a buyer could want, while also running a successful business, requires incredibly hard work. But preparing well will mitigate the stress and should deliver a very positive outcome.”

Is there any pending legislation or tax changes that may impact the market?

Jim Shaw: “There was huge relief that the Chancellor did not hit wealth creators and SME owner-managers by increasing Capital Gains Tax. I still believe that CGT needs a complete overhaul. It seems extraordinary that those who speculate on property when the underlying asset is highly unlikely to lose value, pay the same tax as an SME business owner taking real risk who has spent years building a successful business and providing jobs for a local community. The levels of risk and effort and vastly different.”

Ewan MacKinnon: “This time of year, always breeds worries that the upcoming Budget will include a change to CGT, leading to a flurry of activity as deals race to completion ahead of 5th April. However, there is no sign of anything on the horizon this year that would be particularly troubling in this regard.”

What is driving the international interest in UK businesses?

Jim Shaw: “The 2016 drop in the Pound, due to Brexit, has undoubtedly made UK assets much more desirable. Perhaps most importantly, however, over the last decade the UK has really established itself as an innovator in technology which is bound to garner eager interest from international tech companies.

“Brexit is also driving interest in that international companies are opening offices in the UK – and vice versa – to ensure that trading links are maintained.”

Ivan Sedgwick: “The UK as one of the poorest performing markets of the last few years has of course attracted attention. US companies remain comfortable with the legal system, the regulatory environment, and the language. There is good technology and R&D even if mainstream manufacturing is a shadow of its former self and there are few barriers to entry. So far, however, the activity has tended to be in larger rather than smaller companies.”

Ewan MacKinnon: “Quite simply, the UK has some of the world’s best and most innovative growth businesses. Combine this with its improving economic fundamentals and the relative stability achieved by the successful vaccine rollout, and the appeal of the UK is obvious.”

Fraser Thorne: “The UK will always hold a special interest for international investment, given our flexible recruitment laws, solid legal structure and relatively stable political outlook. On top of this, valuation of UK companies still lags that of US peers by some margin.”