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Mergers & acquisitions in 2023: Back to reality

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December 16, 2022

As we look to the mergers and acquisitions (M&A) market ahead, let us reflect on the words of rapper Eminem: “Back to reality, ope there goes gravity.”

We’re coming off years of record highs that would be impossible to sustain indefinitely.

With that said, the 2023 market isn’t expected to tumble but simply fall back to normal.

Last year at this time, deals were moving fast and furious.

Lending was aggressive and many business owners were coming away with premium valuations.

Despite the uncertainties of COVID-19 and supply chain disruptions, it was all things go for M&A.

Now, the market is expected to rebalance.

Rising interest rates have cooled lending, recession fears loom large and international unrest will continue to plague the energy markets.

And yet, the outlook is not as bad as might be expected.

Financial buyers (e.g., private equity and family offices) hold $1.68 trillion in dry powder that needs to be deployed.

As long as private equity continues to provide returns that exceed the stock market, we should see this investment model continue.

It’s changing the dynamics of M&A so that demand for lower middle market businesses is expected to remain strong.
Sellers activity
Baby Boomers make up a large percentage of business owners – an estimated 41%.

They’ve had a nearly 15-year run since the Great Recession that’s delivered significant returns and headaches alike.

Many sectors still report that demand exceeds capacity, so some owners will sell because a business on a growth trend yields higher valuations.

And yet others with a successful company will exit due to age, owner fatigue or a desire to get out before the market truly does take a turn.

Meanwhile, private equity is well-capitalized.

With money to spend and a timeline to do it, these investors should help keep valuations high.

It’s an interesting phenomenon and will reshape a recession’s impact (if we enter one).

We expect business owners will continue to come to market rather than miss out on this unique period in M&A history.
Rising interest rates
Interest rates jumped in 2022, which pushed borrowing costs to levels we haven’t seen since 2008.

It’s simply going to cost more to finance a deal.?
So far, the biggest impact has been on middle-market deals of more than $10 million in EBITDA.

There are fewer lenders in that space, and they’ve pulled back.

M&A advisors across the country are reporting it’s harder to get those larger deals done.

However, with more lenders serving the lower middle market, the pullback hasn’t been nearly as noticeable.

It’s possible we’ll see more buyers shift down market to take advantage of better leverage and valuation opportunities.
Talent issues
Keeping management talent remains a concern for lower-middle market businesses.

As Baby Boomer owners look to retire, the same goes for their leadership team.

That can complicate sale opportunities, as private equity buyers need C-suite people in place to run their acquisitions.
Business owners may find their buyer pool has shrunk if they don’t have proven operators to maintain the business post-transition.

Owners who are hoping to sell in the next couple of years may want to prioritize succession planning.

M&A can play a role here. 

Owners without a clear path to succession may want to sell a few years ahead of their preferred exit date. 

If you’re willing to stay on for a two- or three-year transition, that reduces risk and gives buyers more runway to secure new leadership.

However, when a business has good management in place, owners may want to consider incentive or partnership strategies that give key employees a chance to share in some upside.

This can help retain key leaders and ensure you have the talent necessary to keep the business attractive in a sale.
Talk to your advisors about the best way to structure these plans.
Industry outlook
As always, acquisition trends will vary by industry.

Industrials and manufacturing should continue strong.

The supply chain is catching up, but the lessons of the last two years will fuel demand for stateside production.

Businesses with maintenance contracts and recurring revenue should do well, and healthcare is expected to maintain robust valuations.

On the other hand, construction deals may slow down as these companies contend with inflation and rising interest rates.

Deals will continue to get done across the market, but some sectors will be tempered as buyers and lenders see risk ahead.
In uncertain times, buyers make a “flight to quality,” looking for businesses with strong fundamentals.

With the potential for economic headwinds ahead, it’s more important than ever to plan early and make sure you can attract the necessary buyers.

Talk to your professional advisors about M&A trends and opportunities affecting your business.

Scott Bushkie is the founder and president of Cornerstone Business Services.

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