Market conditions have dealmakers digging deeper for elusive M&A gold

Interest rates are, unsurprisingly, top of mind for the dealmakers we spoke with for this year’s state of M&A article. COVID still reverberates through the deal market, contributing to diligence challenges and extending timelines. Dealmakers are also carrying forward concern over inflation, as well as geopolitical uncertainty, with the latter weighing on those doing deals across the ponds (though, as one dealmaker notes, circumstances in the EU may have created opportunities for buyers) and those at home facing an election year.

Still, deals are getting done. The money is out there — even if it’s often more expensive than many would prefer — and high-quality companies, or those with management teams that have shown deftness in the face of market adversity, are the main benefactors as buyers increasingly put businesses under higher powers of magnification.

Checking in with PitchBook’s annual Global M&A report, this one from 2023, it estimates that more than 40,200 M&A deals were announced or completed in 2023, which would rank as the third-highest total on record. However, PitchBook found that the total value of deals closed or announced in 2023 came in at $3 trillion, a 15.8 percent decrease from 2022. For context, the author notes that the previous year’s decline was much steeper: 23.4 percent.

Fortunately, when it comes to the view from the sellers’ seat, Boyd Pethel, First National Bank executive vice president — metro markets, says middle-market corporations are getting deals done.

“Whether due to ecommerce investments, scaled space needs or better supply chain management necessitated by the pandemic, many businesses have come out of the past few years with greater efficiencies in place,” Pethel says.

Boyd Pethel

“These enhanced efficiencies have led to better cash flow, resulting in a higher value. However, equity is still king, and even a company that wants to be sold and has an appropriate value may struggle to find a buyer who is in a financial position to close a transaction.”

Several area dealmakers offered their take on the current market, how buyers and sellers are faring, and their advice for those transacting this year. Here’s what they have to say.

A Cadillac and Chevy market

The M&A slowdown of 2023 was the first time Matt Kaulig, founder and board member of Leaf Home, and executive chairman of Kaulig Companies, experienced a change in the market, and it’s proven to be an interesting challenge to take on. That market slowed down Kaulig Capital, his family office, in terms of the number of new deals, even though he says he feels no need to put money to work in an environment where deal quality is weak and interest rates are high. Instead, he says they can double down on investments in their existing portfolio, and the team can be hyper-focused on developing who they want to be as a firm.

“We have identified verticals where we are strong, as well as areas where we want to allocate more capital,” Kaulig says. “When the markets shift again, my team will be ready to go.”

Matt Kaulig

Bob Girton, Edgewater Capital partner, says this past year his firm saw consistency in the number of deal opportunities, aligning with the firm’s historical averages. However, they noticed a substantial decline in the quality and suitability of the opportunities relative to their investment criteria.

“This trend reflects broader market challenges driven by rising interest rates, economic and geopolitical uncertainty, and ‘noise’ as we work through the implications following COVID — destocking, supply chain adjustments and margin stability,” Girton says. “This has directly impacted capital structures and led to a disconnect between buyer and seller valuation expectations.”

While Rocco Di Lillo, chairman of PCX Corporation, City Visitor Inc., PorchLight Destination Services and Advanced Hydro Solutions, sees the market as still recovering from last year’s jolt of sharply increased interest rates, he says buyers and sellers now are getting used to the fact that leverage money is no longer “virtually free.”

Rocco DiLillo

There is also a sharp division in valuations:  Extremely successful companies in sectors such as software, medical, high-tech and other attractive industries are worth premium values to strategic and financial

buyers. More “normal” companies are saleable, but not at premium prices, and companies encountering difficulties are trading, if at all, at very low prices.

“It is as if the Cadillacs and Lincolns are selling above the sticker price while the Chevys and Fords are selling at discounts,” Di Lillo says. “I have never seen the gap be wider.”

Greater deal scrutinty

Looking broadly at the macroeconomic factors that are contributing to today’s conditions on the ground, Ansir Junaid, founder, chairman and CEO of SupplySide Group, says most in the dealmaking space are focused on assessing inflation and how that might impact costs, pricing strategy and consumer demand. He says the view on interest rates has shifted since December 2023 from the sense that there will be multiple rate cuts in 2024, to appearing as if there won’t be much relief in that area this year and even an outside chance of additional rate hikes. There remains uncertainty around how long consumer spending will remain resilient, whether corporate profits will hold up after being reasonably strong in Q1 across numerous sectors, and to what extent some of the issues in the commercial real estate sector will further limit lending availability in the market.

“All of these factors make underwriting processes more difficult in terms of assessing the normalized earnings potential for 2024, 2025 and beyond,” Junaid says.

While Bobby George, founder and CEO of Ethos Capital, says he generally doesn’t pay much attention to macroeconomics, he does if they will affect his cost of goods — for example, potential tariffs, etc. But that vulnerability might dissuade him from investing.

“If a deal or company is too sensitive to things like interest rates, etc., it is too thin for us anyways,” George says.

Bobby George

From Girton’s lens, several factors stand out as particularly influential for M&A activities. Interest rates have fundamentally altered deal valuations and the financial structuring of acquisitions. And geopolitical tensions, while not the primary driver, add another layer of complexity to strategic planning.

“Shifts in global trade policies and regional conflicts could indirectly influence market stability and confidence,” Girton says. “Furthermore, the broader shift toward a multipolar world, with significant capacity building in regions like Asia and the potential for overcapacity, could reshape demand-supply dynamics in critical sectors such as pharmaceuticals and chemicals.”

He says a key focus for them has been the government-driven reshoring efforts, particularly in sectors critical to national resilience such as pharmaceuticals, semiconductor manufacturing, and green technology.

“These initiatives are aimed at strengthening supply chains and reducing dependency on foreign supplies, which present both challenges and opportunities in M&A,” he says. “For instance, the incentivization of domestic production could lead to an increase in investments and partnerships, aimed at capitalizing on these government incentives.”

Given these factors, he says their approach to M&A is increasingly centered on identifying opportunities that offer not just financial but strategic resilience — businesses that can navigate these macroeconomic currents effectively.

Bob Girton

“We anticipate that this heightened focus on due diligence and strategic fit will become even more pronounced as companies and investors alike seek to mitigate risk in an uncertain economic environment,” Girton says.

Umberto Fedeli, CEO of The Fedeli Group, says he’s keeping an eye on inflation and interest rates, which he says are two of the most important factors when it comes to the macro environment. The third he’s monitoring is the political environment.

“Elections do have consequences.”

And though interest rates are on everybody’s minds, Di Lillo says there is also the fear by some of a looming recession. He also see some anxiety about the lack of any consensus on fiscal policy out of Washington.

“With our annual deficit exceeding a trillion dollars — a totally unsustainable figure — this concerns me,” he says.

Wanted: high-quality companies

After a lackluster M&A cycle for sellers in 2023, and due to a fair amount of dry powder that exists within private equity, Junaid says there is an expectation for greater transaction volume in 2024, which should favorably impact sale prices for sellers. However, he says he expects prices will remain depressed from 2021 peak levels because of financing availability and other macroeconomic factors.

How sellers are facing these challenges depends on how well the sellers’ management teams have responded to the various macroeconomic forces impacting their businesses in the past year.

“Buyers are spending more time and resources in deeply evaluating the business across all functional areas,” Junaid says. “Strong management teams who have shown a mix of creativity and operational discipline will be looked upon favorably in a sales process and achieve better results, whereas those teams who have not shown an ability to proactively manage their businesses through the past several years will generate lower exit valuations. In general, the headwinds on financing will serve to lower exit valuations for all sellers.”

Sellers with high-quality assets continue to see robust interest, often commanding premium valuations. For sellers on the smaller end of the market, Girton says the ability to present their businesses as well-structured, with clear value propositions, clear understanding of customer demand drivers, and potential for growth, remains a significant advantage. 

“These sellers are finding success by focusing on core business strengths that are valuable, repeatable, defensible and scalable — qualities that attract strategic and PE buyers looking for essential assets to round out their portfolios,” he says.

As the market adjusts to new economic and geopolitical realities, those who can navigate the current complexities effectively are achieving favorable outcomes.

“Sellers who have adapted to the changing landscape by enhancing their operational capabilities, strategic positioning, and don’t face structuring changes to their markets and market drivers, are particularly well-placed to enjoy premium valuations as both PE and strategic buyers have record powder available for investment,” Girton says.

Umberto Fedeli

Fedeli says he’s been involved in a number of transactions that have been delayed and/or fallen through because of financing challenges and cost of capital. However, there are still a lot of buyers, a lot of capital and a lot of desire, a sentiment somewhat echoed by George: “There is a lot of money available.”

Sellers saw some pretty high valuations in the past few years, and those who chose not to sell in 2021 or 2022 may find themselves looking at a lower purchase price for a company with the same performance, Kaulig says.

“I hear a lot of sellers claim that the economic environment is slowing back to ‘pre-COVID norms, using this as an excuse for slowed topline growth or profitability,” he says. “It may be hard, but as I always say, If you aren’t growing, you’re dying. Sellers need to find a way to demonstrate continued growth among these challenges. Buyers want to see growth. And that will lead you back to stronger valuations.”

Digging deeper

For buyers, Junaid says today’s market is still an ongoing process. There appears to be some movement in the market toward lower valuations, given the recognition that the current financing environment will remain for some time, and uncertainty around inflation, GDP, etc., will remain. That could lead to opportunities for buyers.

“For those sellers who must sell in the current market due to a desire for an entrepreneur to exit, etc., the resulting multiples on EBITDA will fall below those that would have been paid in previous years, which will favorably impact buyers’ returns,” he says. 

There are, however, two main challenges facing buyers. One is that financing availability and pricing will serve to increase the amount of equity that will need to be invested in any transaction. The second is having an accurate read of the near-term and long-term performance of target businesses will continue to be more difficult than in prior years. 

“Given the issues from COVID and then those coming out of COVID impacting inflation, labor markets and supply chains, these factors will make it difficult to leverage historical performance in assessing prospects,” Junaid says.

Ansir Junaid

“There has been a considerable credit squeeze in the commercial real estate market during the post-COVID period. The packaging and storage industry will see improvements once there is credit availability at a better rate, and ease in international tensions, and insured economic policies under upcoming government.”

Kaulig says when a sector’s growth is impacted by COVID and the economy, part of the diligence process involves determining what aspects of this growth are here to stay, and what parts were artificially inflated by these trends.

There are going to be winners and losers coming out of these record-breaking years, and I think we can already see the divide forming,” he says. “Kaulig Capital is being diligent and patient with new investments right now, waiting for opportunities to come along that we are confident are winners.”

Still, buyers are finding unique opportunities shaped by regional market dynamics, according to Girton. In the European Union, the environment is ripe for strategic acquisitions, particularly in sectors disrupted by energy changes and supply chain challenges. 

“We’ve noticed an increase in forced or distressed sales, especially in corporate divestitures, where companies are compelled to shed non-core assets,” he says. “This creates a fertile ground for buyers like Edgewater to acquire valuable assets at reasonable and sometimes compelling valuations.”

Conversely, in the U.S., he says the landscape presents different but equally strategic opportunities.

“We’re seeing an interesting countertrend where assets that may have fallen out of favor due to shifting ESG priorities are now undervalued,” Girton says. “Additionally, corporate divestitures driven by portfolio realignment are more frequent, as companies seek to focus on core operations and shed peripheral interests. Government incentives are also spurring investments in industries aligned with megatrends such as advanced manufacturing and green technologies, creating openings for informed buyers.”

Pethel says getting to an appropriate equity position is one of the main considerations for middle-market corporations looking to acquire right now, but there also are still the everyday boxes to check.

“For example, if a company they are purchasing engages in global sourcing, we want to know the details and if there are alternative sourcing methods in place, if needed,” Pethel says. “Closely analyzing a deal is beneficial for all parties and stakeholders.”

Perspective shift

George has a one-word answer for the obstacles he sees affecting dealmaking today: “Fear.”

Similarly, as Kaulig puts it: “The biggest obstacle is everyone saying deals are harder to get done in this environment. We need to shift our mentality.”

He says interest rates may stay high, sellers may have lofty valuation expectations and quality deals may be harder to come by, but he expects his team to continue to add value across the portfolio.

“We aren’t going to slow down; we are going to be innovative and create our own opportunity,” he says, “whether that’s working hard to uncover unique investment opportunities or thinking entrepreneurially to accelerate our existing portfolio companies.”

Pethel says the biggest drivers are the rate environment and inflation, which go hand-in-hand.

“The forecast on those factors has been all over the board, with some pundits who predicted multiple Fed rate decreases just months ago anticipating far fewer now,” he says. “The unknown always weighs on people’s minds and decisions, resulting in a more cautious approach to M&A and growth for middle-market companies.”