M&A activity is showing signs of recovery after a long pandemic-induced lull, and with private equity funds and business owners trying to complete deals ahead of tax and regulatory changes brewing in the Biden administration, 2021 could see a surge in M&A.

Although according toRefinitiv data, global deal volume was down 12% year-over-year at the end of the third quarter, and deals involving U.S. companies were down 32%, there are signs of an active recovery in the market.

"We're seeing M&A volumes pick up post-pandemic," said Scott Rhodes, managing director at Citizens M&A Advisory, during aFrazier & Deeter webinar. "During strict lockdowns, all our deals were paused, but the fundamentals remained solid. So, for businesses that are pandemic-resilient, all processes have restarted and are progressing well."

Kirkland & Ellis partner Daniel Wolftold Bloombergthat the pandemic has made organic growth difficult, so companies are seeking inorganic alternatives to attract investors.

"Investors are rewarding growth," he said. "It's an active M&A environment."

Corporate executives share the same view. In asurvey conducted by Dykema Gossett law firm, more than 70% of respondents expect the M&A market to strengthen over the next 12 months, compared with only 33% last year.

Tax implications

Deal experts say it remains unclear how much the Biden administration, backed by a Democratic-controlled House and Senate, will affect deal activity through tax law and regulatory changes. But the new administration has proposed raising the top corporate tax rate from 21% to 28%, a move that would directly increase the cost of future deals.

"Tax policy will have a significant impact on M&A activity," Hogan Lovells lawyer Aaron Cutler said inLaw360 report.

Equally important, for founders and business owners seeking an exit, a proposal to treat long-term capital gains as ordinary income would raise the tax rate on proceeds from a business sale from 20% to 37%. After 2025, the rate would rise from 37% to 39.6%, the same level as before 2017.

"Of course, in an M&A deal, business owners would incur an additional 17% tax burden from selling their business," LeighAnn Costley, senior tax partner at Frazier & Deeter, said in awebinar. This additional 17% tax burden stems from the difference between the 20% capital gains tax and the 37% ordinary income tax rate. The change applies only to sellers earning more than $1 million.

Limited partners and general partners of private equity funds would not be affected by this change because they do not apply capital gains tax in that transaction.

"Private equity firms have not adjusted their exit plans due to tax policy changes," Rhodes said.

Even if changes in capital gains and corporate tax rates do not dampen deal volume, they could still affect pricing, as business owner sellers seek higher valuations to offset the higher tax burden.

"Under the Biden plan, a business sold at 10 times EBITDA would need to sell at 13.2 times EBITDA to achieve the same after-tax return," Rhodes said.

Window of opportunity

Deal experts say that given how Congress operates and the competing priorities facing the Biden administration, these and other tax law changes are unlikely to take effect before early 2022. Therefore, if concerned about rising tax burdens, 2021 will be the window to complete deals.

"If the Biden administration signals to us before the law is passed that it does not intend to apply it retroactively, you will see a wave of eager exits," Rhodes said, "especially since we have a backlog of businesses that had considered starting a sale process but held off due to the pandemic, focusing on business performance."

Rhodes' firm primarily serves sell-side businesses, and he said companies should begin planning for a sale in the coming months to complete deals by year-end.

"We will encourage prospective clients to start the planning process early," he said. "The first quarter will be an intensive preparation period so that people are ready to seize the opportunity before the window closes."

Antitrust concerns

On the regulatory front, analysts do not expect significant divergence in M&A oversight from the previous administration, although the Biden administration is expected to take a tougher antitrust stance.

Increased scrutiny is expected "of vertical and conglomerate mergers, acquisitions of nascent competitors, and expansion by dominant firms into adjacent industries,"Dechert LLP analysisnoted.

Another area under increased scrutiny is cross-border deals, especially those involving Chinese companies. The Biden administration is expected to maintain the previous administration'sstrict oversight。

of such deals on national security grounds."The heightened scrutiny of Chinese companies acquiring U.S. firms during the Trump era is expected to continue,"Reuters reported. "Over the past four years, the U.S. has blocked many Chinese acquisitions on national security grounds, especially of U.S. tech companies, and has even ordered some Chinese companies, such as the owners of social media apps TikTok and Grindr, to divest."

The Biden administration may also take a tougher stance on mergers in the healthcare sector.

"Biden has called for retroactive review of recent healthcare mergers approved by the Trump administration,"Conner Strong analysisnoted. "Biden has pledged to use antitrust powers to address market consolidation in healthcare (such as hospitals, provider groups, insurers, etc.) and to review future acquisitions based on their impact on labor markets, low-income communities, and racial equity, as well as pricing and competition."