Since the end of the pandemic, many in the deal-making community have been waiting for news of a slowdown in M&A activity. And that time has come, although the news is not dire, for several reasons I’ll go into in just a moment…and the deal-makers I’ve spoken to remain upbeat and positive too.
But, in black and white, there has been a slowdown from the end of 2022 into the beginning of 2023.
According to the Firmex Deal Flow Bulletin for Q2 2023, the numbers of deals in North America was only 1% lower than Q4 in 2022. And then they expect a decline of 2% in Q2.
But like I said, there is optimism out there. According to M&A professionals interviewed for the report, 55% feel positive about the M&A market overall. Plus, 36%. Of these merger advisors also predict increased volume in Q3 of this year.
So what’s behind this ongoing slowdown in deals? There are several factors:
- The possibility of recession.
- The increase on earnouts and other contingent provisions.
- Higher interest rates.
- Inflation pressure.
- The scarcity of debt financing.
- Uncertainty about the near-term economy.
Taken separate or together, these factors result in deals taking longer to close…and a slowdown in M&A activity overall. Not to mention, valuations of acquisition targets have been pushed down as well.
In the face all these challenges to acquiring targets they want, some Buyers have actually hit the “pause button,” preferring to see if get a better deal from lenders and the overall economic climate improves.
At the same time, you have Sellers who fear a recession and think that selling now is the best way to preserve the value their company has now.
It’s just another indication of the confusion and conflict of opposing viewpoints in the M&A world that could be contributing to a slowdown in dealmaking.
Here are a couple other points of conflict that show the slowdown isn’t all bad news:
- Interest rates mean the cost of financing is higher, but this also means that target prices will start coming down.
- Buyers are also getting more buyer-friendly terms. For example, Sellers are willing to take on more risk, so they are getting creative with including earnouts. That means not insisting all cash upfront but rather agreeing to earn contingency payments based on performance post-closing. They’re willing to receive this instead of cash equity into the new company.
Will 2023 Be That Bad?
Another way to look at it this issue is that deal-making is simply returning to normal levels pre-pandemic and are only a somewhat dramatic drop when compared to the record highs of M&A activity in 2021 and 2022 as pent-up demand from during the pandemic was released.
In many ways, it’s not really “fair” to compare M&A now and just after the pandemic. It’s a whole different reality.
I also feel that even in the face of powerful macroeconomic forces that M&A is resilient, especially in the lower middle market, which are typically privately held companies.
But overall, when you factor in the massive publicly held companies, the stats show that M&A has slowed down.
Still, the bottom-line is that, unlike in the go-go post-pandemic period, people on all sides are more sensitive to risk. For one thing, they are taking more time and care with due diligence – another factor slowing down deal-making.
As a result of this atmosphere of risk (whether real or imagined), transactional liability insurance, such as Representations & Warranty (R&W) insurance, has grown in popularity because it transfers risk away from both parties.
And thanks to the slowdown and the increased number of insurers out there, carriers have been forced to become much more competitive on price. That means R&W rates are continuing to come down from peak levels. Those rates are expected to drop through the end of 2023.
This is a particularly positive trend for lower-middle market companies, the subject of deals from $1M to $20M. For them, an R&W policy that takes away all the risk of the deal costs just $15,000 to $20,000 per $1M in Limits; therefore, deals with values up to $20M can secure a policy insuring the FULL transaction price. That’s a lot of peace of mind for what it costs.