Deal Flow Persists in M&A Despite Economic Uncertainty

by Mark Wright

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The end of 2022 was marked by economic uncertainty and fear of recession. While deals may be complicated by continued volatility, the sentiment surrounding the future of the M&A market is increasingly positive, according to Firmex’s Q4 2022 Deal Flow Bulletin, which surveyed investment bankers, business brokers, and other professionals involved in middle-market M&A. 

Advisors anticipate significant activity. Acclimation to the new economic reality has prompted adjustments in deal conditions, but buyers and sellers continue to be very interested in pursuing middle-market transactions. 

Sentiment by the Numbers 

In the short term, it is true that deal volume and valuation have fallen off from the record-high levels amid the 2021 spike. But taking a step back and looking at market trends over a longer time frame shows that current levels appear to be more of a stabilization, reflecting a return to pre-pandemic conditions.

More than one-third (36%) of Deal Flow Bulletin respondents reported increased deal volume over the past three months, while 38% reported no change and only 22% saw a decrease. These numbers are particularly notable in light of geopolitical conflict and economic concerns.

Looking forward, we see expectations exceeding recent performance, with 43% of respondents saying deal volume would increase over the next three months, and only 19% saying it would decrease. As one M&A advisor stated, “I’m optimistically cautious. So long as the M&A investment model continues to outperform other asset classes, buyers will continue to make acquisitions.” 

These predictions fall in line with Firmex’s projections for deal announcements in the fourth quarter, expected to beat Q3 by 11% in North America and 6% in Europe. These forecasts are based on the number of virtual data rooms created for deals on the Firmex platform, which has proven to be a reliable indicator of future activity. 

When it comes to the broader economy, however, more than half (56%) of surveyed professionals believe a recession is likely over the next year. And while deal flow may continue unabated, there are other signs that current economic conditions – and a wary future outlook – are affecting M&A activity. 

Comparison: Buy-side and Sell-side M&A 

The number of new buyers entering the market has slowed from peak levels in 2021, and respondents are equally likely to say that the number is increasing or decreasing. This largely depends on where these deal advisors are focused on: PE-backed companies and PE firms are seeing an increase in activity, while SPACs and VC firms are showing a decrease. 

While there may be contention regarding whether the number of buyers is increasing or decreasing, the picture is much clearer for sell-side M&A, with 77% of surveyed professionals stating that the number of companies considering a sale either remains constant or is increasing. Seller activity is not expected to decline despite future economic conditions, as the motivation to sell is based on a variety of factors (including difficult future conditions, owner retirement and/or the desire to act before a recession or further interest rate increases). 

As one VC advisor noted, “interest rates and recession fears are taking some steam out of the market, but aging owners still need to sell, and there is still a lot of capital to be deployed.”

Despite these buyer and seller shifts, the demand for deals has led to a stabilization that is reminiscent of pre-pandemic conditions. 

Lower Appetite for Risk Causing Increased Delays 

Longer, more complex negotiations are leading to delays in overall deal closures as buyers conduct more rigorous and detailed due diligence. Over half of surveyed advisors say it is taking longer to close deals and nearly as many say the gap in prices between sellers and buyers has widened in the last three months. Overall, buyers are less willing to take on risk than they were a year ago. 

According to one advisor, “buyers want to spread the risk between themselves and the seller.” 

To bridge the gap between buyer and seller expectations, M&A professionals are turning to creative deal structures to reach a middle ground. This includes an uptick in earnouts, tying company valuation to post-deal performance to soothe anxieties around risk. 

Looking Ahead 

As the M&A market adjusts to accommodate global economic conditions, deal volume is not in the spotlight – it’s the motivation for deal activity that is. Despite economic headwinds and an uncertain market, M&A advisors have made it clear that the market has stabilized for now. 

Mark Wright is the General Manager, Firmex.