Back in May, when the pandemic was at its height, we published a blog that offered a bit of optimism. We described why —despite the volatile market —growth equity was still open for business.
Six months in, it feels like a good time to offer an update. And though the overall economic outlook is still hard to predict, we remain optimistic. Despite it being a difficult six months, now may be the best time to partner with growth equity.
We’ve heard from various management teams, entrepreneurs, and founders that they feel like they missed the boat. That they should have de-risked in a bull market, and entered into deals before COVID-19 struck. But this is as misguided now as it was in May.
In fact, this may be the best time to consider a transaction due to continued market strength and additional risks, related to the ongoing pandemic and potential increases to capital gains tax.
Market Signals of a Strong Year-End
Despite all the doom and gloom of 2020, there are reasons to be positive as we approach the end of the year. For obvious reasons, it’s been a tough year. According to the Pitchbook US PE Breakdown Q3 2020, deals for Q3 were down 20.6% in dollars compared to 2019. However, we are seeing high market trading multiples across sectors. This is a big tailwind. And earnings optimism is driving markets higher.
There are many positive signals in the private equity market; More than 5,500 buyouts have been announced so far this year, the highest YTD total since 1980. Notably, we have seen Francisco Partners and Evergreen Coast Capital acquire LogMeIn; Thoma Bravo acquire Instructure; BMC acquire Compuware; and Advent and Crosspoint acquire Forescout. Private equity firm Stonepeak is looking to enter the cable and internet services industry, with a $8.1 billion purchase of Astound Broadband. Another private equity firm, Advent International, is seeking to acquire Nielsen’s consumer goods data unit for $2.7 billion.
In the global mergers and acquisition (M&A) market, data for the first three quarters is well below 2019 levels. However, according to Baird Global M&A Monthly, beginning September 2020, U.S. M&A activity showed signs of bounceback.
Megacap companies (companies market capitalization above $200 billion) involved in tech are seeing strong performance in the investment market. Apple has recently launched their 5G-enabled iPhone, a move investors are looking to drive substantial growth in the coming months. Amazon saw extraordinary performance on Prime Day and Black Friday.
Even airlines, who took a beating during the pandemic, are showing that the industry is far from dead. In the case of Virgin Australia, over 20 companies showed interest to invest, with Bain Capital eventually winning with a $3.5 billion buyout.
Strong IPO Performances Show Growth Potential of Tech
At Norwest, we are seeing increased activity and deal flow from founders who are looking to transact, and bankers who are launching new deal processes. Founders are becoming more willing to discuss de-risking, taking chips off the table and attacking the next phase of growth with a war chest and a support system in place. We are witnessing a fascinating rise in SPAC (special purpose acquisition company) mergers, particularly in the transport and autonomous driving technology space.
This general mood of optimism is bolstered by some strong IPO performances over the course of this year. At the time of writing, there have been 201 IPOs priced this year, a 32.2.% increase over last year, with US IPO performance outpacing the S&P 500, up 96.5% YTD vs 14.2% YTD for the S&P 500 Let’s recap a few.
On June 3, 2020, the stock price for ZoomInfo began at $21. That figure soared to $34 per share by the end of its first day on the Nasdaq. That’s an impressive 62% single-session gain. A week later, on June 10, ZoomInfo’s share price peaked at $64.40. For the second quarter, ZoomInfo’s revenues reached $110.9 million, a whopping increase of 62%.
On July 1, 2020, Lemonade Inc. entered the investment market as 2020’s strongest IPO of a U.S.-based company. Within their first day of trading, their price per share had more than doubled from a previous range of $23 to $26 apiece to as high as $70.80, a 144% spike. It dropped to $69.41 per share the following day, but it was still a grand showing by the mobile-based insurance startup.
E-commerce enterprise BigCommerce enjoyed a massive increase in share price in its IPO during its first day of trading in August. Opening at $24 per share, the company’s stock price rose to $72.27 at the end of the day. That’s an uptick of 201%. The following day, BigCommerce stock opened $68 per share and was as high as $91.80 around noon.
One of the most anticipated IPO listings of 2020, cloud database provider Snowflake’s opening price per stock, when it went public in September, was $120. This made Snowflake a blockbuster IPO; the biggest IPO for a US-based software firm. The company opened at $245 per share the following day. Optimism in Snowflake’s growth is palpable. “Snowflake is the fastest-growing software company in history at scale, and we believe it will be the fastest ever to $5 billion in revenue,” wrote Trust Securities analyst Joel P. Fishbein Jr.
Duck Creek Tech
Duck Creek Technologies went public on August 15, 2020 with an initial price offering at $27 per share. By the end of the first day of trading,the software-as-as-a-service (SaaS) solutions provider raised $405 million. Duck Creek recently announced its plan to enter Europe and Asia, with proceeds from the IPO to finance its expansion.
Enterprise digital collaboration platform provider Asana went public in one of the most anticipated IPO moves in 2020. Initially priced by the NYSE at $21 per share with an estimated market valuation of $3.9 billion, Asana’s stock price soared to $28.80 apiece, a 37.1% jump from its reference value.
Pandemic & Capital Gains Pressures
Despite the causes for optimism, challenges remain. There are some potential risks to be aware of that may ultimately drive the desire to explore a transaction sooner
The big one here is potential changes to capital gains tax. Under potential forthcoming policy changes, the capital gains for taxpayers earning $1 million or more could be set at 39.6%. If this change happens then founders who sell all or part of their businesses may see their tax burden nearly double in size.
Tax changes will probably see capital gains and dividends taxed at ordinary income tax rates for those making at least $1 million. At present, most capital gains are taxed at 15% or less. Unrealized capital gains due to death will also be taxed.
There are also calls to increase the corporate tax rate from 21% to 28% and enforce a tax on companies that outsource jobs. American companies operating overseas will have to pay double their taxes on foreign earnings.
Along with capital gains, there are the ongoing pressures of the pandemic. The latest wave of COVID-19 infections is already impacting the investment sector. As with the first wave, the bounceback will take some time.
Reasons for Optimism
Being honest about the challenges is no reason for pessimism. Investors have dealt with capital gains tax increases before, and continued to thrive. When it comes to the pandemic, news of a COVID-19 vaccine has sent the stock market soaring. Normality could be returning sooner than anyone expected even a few weeks ago.
Yes, it’s been a turbulent year, and the market has felt it. But growth equity is still very much open for business. Savvy investors are continuing to deploy capital, and this will only increase as a vaccine gets closer and capital gains challenges can be absorbed. There is no reason to delay!