The economic environment has mostly stabilized following the inflationary shocks of 2021-2022, and a strong Q4 2023 suggests that M&A may be in line for a comeback in 2024. The following trends demonstrate why now is likely a great time to sell your business.
M&A Activity Fell to a 10-Year Low in 2023
After hitting an all-time peak in 2021, M&A activity declined in 2022 and 2023. Both the number and value of transactions completed in 2023 represented 10-year lows. Pricing was down for much of the year, although a strong Q4 in 2023 boosted yearlong average EBITDA multiples to approximately 8.5x-9.0x (with transactions in the core middle market of US$100 million-US$250 million as the strongest performers).
Expect an M&A Resurgence in 2024
The initial Q1 2024 transaction pipeline is strong. Pricing should improve by approximately 0.5x-1.0x EBITDA for the middle market. There is significant buyer “dry powder” available for deployment — up to US$4 trillion.
The second half of 2024 could see a “super-charged” market if it appears that President Biden will win second term and Democrats will control congress — there may be concern over a significant capital gains tax increase.
The majority of CEOs expect at least one M&A transaction in the next three years. Small- and middle-market deals will continue to form the bedrock of M&A because:
- It’s easier to find financing to support smaller transactions.
- Private equity can still accomplish the desired returns through a series of small- and middle-market deals and platform buildouts versus large standalone transactions.
- Private equity firms and family-owned businesses will continue to look for exit sales.
Macroeconomic Picture Continues to Brighten into 2024
Investors’ long-term confidence remains strong — the stock market was up approximately 24% in 2023 and 7% YTD 2024. Inflation has cooled to the low 3% range, although it’s still stubbornly above the Fed’s preferred 2% target[1]. The Fed currently expected to maintain interest rates at 5.00-5.25% until at least June 2024, but may cut rates to approximately 4.50% by the end of 2024.
The economy grew by 3.2% in Q4 2023 and 2.5% overall in 2023[2] — and many forecasts for 2024 growth are now in the mid-2% range, which further quieting fears of a recession and suggesting we may see the hoped-for “soft landing.”
Financing Headwinds
Transaction financing continues to be a significant challenge — driven by high interest rates, pricing is at a 10-year high, and private credit is not fully able to fill the vacuum. Private equity firms continued to show a preference for smaller transactions with less or no debt financing. Transactions continue to make use of seller financing, rollovers, and earnouts. Strategic firms may look to M&A exits as a less expensive source of cash.
M&A financing is currently at its most expensive level in 10 years. Over the past year, senior financing is 2.5 to 3.0 times adjusted EBITDA (down 0.5x-1.0x vs. historical norms); junior/mezzanine financing is 0.5 to 1.0 times adjusted EBITDA (down 1.5x-2.5x); and interest rates up 200-300 basis points. Bank failures in 2023 led to lower risk tolerance from lenders – increased scrutiny over deals and tougher, more restrictive covenants in credit agreements. More equity may be required to complete certain transactions. Most deals still close to the historical norm of a 50/50 mix of debt versus equity. Many buyers are bridging the gap through a higher percentage of rollovers, seller financing, and earn outs.
Key Trends in M&A Execution and Transaction Terms
Representation and warranty insurance (RWI) has become standard — and slowdown in M&A activity has made pricing and other terms more attractive to both buyers and sellers. RWI has helped make limited-indemnity or “walk-away” transactions increasingly common — and some buyers have even begun to offer true zero-indemnity deals.
Buyers increasingly make use of relatively higher amounts of seller financing, rollovers, and earn outs to protect against risk and keep sellers invested. In competitive, auction-style transactions, timelines have shortened considerably — parties will move very quickly and often without exclusivity. This emphasizes the importance of pre-launch planning and preparation. Buyers now often push to resolve key terms after a transaction is signed, while sellers should ensure important items are addressed up front while leverage is at its highest.
If you’re looking to see your business, or want more information on middle-market trends, reach out to Steve Barth and Steve Vazquez.
[1] From the U.S. Bureau of Economic Analysis (BEA): https://www.bea.gov/
[2] From the BEA
