Coming off record 2021 M&A deal volume and pricing, 2022 M&A activity slowed as national and international events caused buyers to pause while seeking clarity on the direction and longevity of the head winds.
We expect this subdued deal activity to continue through the first half of 2023 with a potential pick up later in the year.
Regardless, there’s a general expectation that the 2023-2024 M&A deal activity will mirror pre-COVID levels and the auction frenzy of 2021 will be forgotten. Since neither sellers or buyers have much control over the “wind direction” for M&A activity, we encourage our clients to focus on their respective controllable factors:
Many lower middle market companies are performing very well even in these challenging times. Revenue, profitability and sales pipelines continue to grow for “old economy” businesses – business services, manufacturing, healthcare and distribution. Supply chains are approaching pre-COVID availability, commodity pricing has normalized, and labor supply remains tight. Most business balance sheets are under-leveraged.
“Good companies” are in short supply and will retain their exit valuations with the following attributes:
- Pristine financials
- Leadership succession in place
- Long-term customer relationships
- Strong recurring revenue stream
- No customer concentration
- Current operating technology in place
With over $1 Trillion of investible capital, buyers have to put their money to work. Therefore, we expect professional investors to focus on several strategies to navigate 2023 successfully:
- Rational deal pricing – the auction pricing of 2021 is over.
- Structure deals that share performance risk with sellers through transaction structure.
- Use of earn-outs, seller equity rollover, and performance escrows.
- Invest in low-risk business sectors – business services, production, health, technology, etc.
- Invest in strong, diversified U.S. geographies with plentiful resources – water, power, etc.
- Revisit secondary platform exits depending on PE’s economic outlook.
- Avoid big deal exposure while investing in lower middle market deal size.