Over the last few years, two dominant forces – high inflation and elevated interest rates – have weighed on corporate investment and challenged the mergers and acquisitions (M&A) market. Geopolitical tensions, disrupted supply chains, and labor market issues have also added to the challenges that have affected companies and business owners looking to plan for the future.

“Probably the largest theme underlying all of these issues is uncertainty. We've been living with a great deal of uncertainty, and that has driven significant caution and a risk averse posture to most market participants, businesses, business owners, and the M&A market,” said Julie Williams, head of Advisory Services for PNC Bank.

In a recent webinar, “How Current Market Themes Impact Today's Shareholder Strategies and Tomorrow's Business Transitions,” panelists shared perspectives on strategies for business growth, increasing shareholder optimization, ownership transitions and liquidity, the value of employee engagement, and the broader M&A market. Panelists included:

  • Melissa McCarthy, head of PNC Corporate Advisory
  • Ginny Saloom, managing director and co-leader of the PNC ESOP Solutions team
  • Larissa Rozycki, managing director with Harris Williams, specializing in M&A and private capital advisory

A full replay of the webinar is available here, and the following is a summary of some of the themes from the presentation.

In the current climate, what strategies are businesses adopting in terms of capital allocation decisions?

  • Amid ongoing uncertainty, many companies have turned inward to focus on financial discipline, working capital optimization, and balance sheet management. In this slower deal environment, it has not been uncommon to find companies who had been preserving capital for M&A transactions to find themselves accumulating even more undeployed capital on the balance sheet.
  • Businesses remain focused on driving growth where they can, whether organically though geographic expansion, or investment in research and development for new products.
  • Many businesses are starting to rethink capital allocation in terms of what it means from a shareholder perspective. They are thinking through thresholds of minimum liquidity they want to preserve on their balance sheet, and how to return excess to shareholders, whether in the form of dividends, distributions, and even share buybacks. Some companies are simply returning the excess cash they have accumulated to shareholders, while others are looking to execute a leveraged recap, which has the effect of shifting the mix of debt and equity on the balance sheet. Excess cash has also created the opportunity for some businesses to execute estate planning in the form of generational transitions.

An Employee Stock Ownership Plan (ESOP) is often viewed as a more seller- or company-friendly alternative, as compared with selling to a strategic or financial buyer, in part because it can address unique objectives for an owner that may be harder to address in other forms of exit. What are some common considerations behind whether an ESOP may be a strong fit for an owner considering a liquidity event or an exit?

  • An ESOP is a broad-based retirement benefit plan, meaning all of a company’s employees participate, rather than concentrate ownership among just a few individuals. It is designed to create liquidity for sellers and can be a good fit for owners who are not necessarily motivated by earning top dollar for the transaction. ESOPs tend to appeal to owners who are focused on preserving the culture and legacy of a family-founded business, or who want to reward employees over the long-term – which is one reason why they may be averse to an outright sale to strategic or private equity. ESOPs can also appeal to owners who still want to run the business but need to create liquidity, since they can sell up 100% of the company but still remain active in the business.
  • There are both personal and corporate tax considerations to ESOPs. If shareholders meet certain requirements when selling shares to an ESOP, they are eligible to defer and even avoid capital gains taxes with careful planning. This can be very compelling to business owners, but it can also add complexity and cost to the transaction. On the corporate side, a 100% S Corporation ESOP is owned by a tax-exempt trust, which means the company generates income but does not need to make distributions to its shareholder for income taxes, effectively resulting in a tax-free company. With enhanced cash flows, the company can repay third-party transaction debt, invest in the business, and also repay the sellers.
  • It’s worth noting the value that ESOPs offer in terms of employee recruiting and retention. The voluntary termination rates of ESOP employees are roughly one-third of the national average. Employee owners of S corporations ESOPs possess, on average, more than double the retirement savings of the average of their non-ESOP counterparts, which can be really meaningful to employees. 

In terms of succession planning, what are some trends for businesses that are family- and founder-owned, and what are some motivating factors for selling at this time in the current market?

  • As the Baby Boomer generation reaches retirement age, a lot of family-owned, multi-generational businesses have owners who do not have a defined successor in place, and this is leading to conversations about what is next for shareholders and for the businesses. Many of these owners are turning to a third-party alternative rather than trying to keep a business as part of a family legacy, as their children may not be interested in being involved in the family business. This is driving a significant amount of M&A deal activity.
  • It’s not just an aging or generational issue; there are a lot of family-founded businesses that are thinking about M&A as a means for growth to take the business to the next level. 

What are some of the trends that have been occurring in the M&A market, and how should shareholders navigate these to position themselves for the most successful sale?

  • To offer some perspective on the M&A environment, it’s important to look back as far as 2020, when there was a tremendous amount of dealmaking and exuberance in the broader M&A market, as businesses were eager to put capital to work both as strategic buyers and financial investors. The macroeconomic challenges that started to emerge beginning in 2021, have had a significant impact on the level of activity of successful deal outcomes. This has not hampered paths toward dealmaking, but it has required a more thoughtful approach on how to bring forth assets in the market, or, as a buyer, taking on the risk of acquiring an asset.
  • We are in the early innings of a momentum shift, given the economy’s resilience and following the Federal Reserve’s recent 50-basis-point rate cut. There is increasing optimism in the M&A market, as confidence has grown in a clearer path toward getting transactions across the finish line and more willingness on the part of both buyers and sellers.

Many family-owned companies aren’t necessarily focused on a transition of the business to a third party or an outright sale, but instead transitioning some level of ownership to family members or to leadership in the business. What are some strategies companies are employing in this regard?

  • One great thing about these generational transitions and shareholder buyouts broadly is how flexible and highly customized that they can be. They create the opportunity to assess what the goals are for every single individual buying and selling shares in this type of transaction, as well as for the family. Therefore, it's important to think about not only people's timing, liquidity, and tax considerations, but also how the transaction will interplay with the goals and capital needs of the business.
  • There is a lot of discussion around the sunsetting that will occur in 2025 in terms of estate tax exclusions. This is likely driving a substantial increase, as well as an expedited timeline, in these transactions.

Brilliant Begins Here

PNC has specialists that can work with you to develop strategies for success in transitioning ownership of your business. For more information, reach out to your PNC Relationship Manager, or contact us.