Middle Market Mergers & Acquisition (M&A) Outlook for 2023
Given how 2022 unfolded, business owners are increasingly asking – “Is this the right time to sell?” The answer depends on multiple variables both external and internal to the company that are difficult to predict.
We have just witnessed an unprecedented increase in interest rates in recent times to bring down inflation. Interest rates in North America increased from close to 0% to over 4% within a period of 12 months. The equity markets declined for the first time in three years. M&A deal activity slowed as the year progressed and acquisition multiples in red-hot sectors deflated. How this plays out will ultimately depend on the way higher interest rates percolate through different industries, and how tight monetary policy interacts with a peculiar mix of high debt levels, abundant savings and a tight labour market. It typically takes six to eight quarters for rate increases to have a full impact on inflation. This happens in phases: first squeezing rate-sensitive sectors such as real estate, then curbing consumer spending as mortgage costs rise, and finally hitting employment and business investment. Weaker demand for goods and services, in turn, forces companies to stop raising prices and eventually start offering discounts, which slows inflation.
In the third quarter of 2022, announced Canadian transactions declined for the third consecutive quarter. The decline in the number of transactions reflects the uncertainty amongst buyers and sellers due to geopolitical turmoil, soaring inflation, rising interest rates and fears of a global recession — that will continue during 2023.
Source: Crosbie & Company Canadian M&A Report – Q3 2022
Despite the dreary outlook, M&A deal forecast may not be as bad when put in perspective. M&A activity reached record levels in 2021 aided by unprecedented government stimulus, which is difficult to beat year after year. So, 2023 even if slower than the last couple of years could represent a return to a more normal market for M&A transactions.
Distinct Capital Partners View for 2023:
From our viewpoint, the level of enquiries for selling a business continues to be strong. We are seeing a number of good businesses with owners looking to either retire or exit coming onto the market. Therefore, we too believe that the frothiness in the market will dissipate and M&A activity in the middle market will return to more normalized levels. This continues to be driven by the following factors:
Continued Retirement of Baby Boomers:
A large number of Small & Medium sized business owners are over 50 years old and they are looking to exit in the short-to-medium term. Business owners have undergone a great deal of turmoil over the past 15 years (stemming not only from the 2008 financial collapse and 2+ years of the COVID-19 pandemic but also from perpetual supply chain issues, employee retention difficulties, higher energy costs, and dramatic demand increases). Small business owners are understandably fatigued; many are retiring, and others are ready for new opportunities.
Strong Demand for Well-Run Businesses:
Both Strategic Acquirers and Private Equity firms took advantage of the accommodative monetary policy and have raised a significant war-chest that still needs to be deployed. Also, Buyers will increasingly focus on smaller deals (lower middle market), as recessionary fears trigger a “small item effect” – smaller purchase over a larger purchase.
Steadier Valuation Multiples for “Basic” Lower Middle Market Businesses:
According to a survey by Firmex (Deal Flow Bulletin Q4 2022), most M&A firms see valuations remaining ‘average’ (as opposed to ‘high’ or ‘low’) and see the valuation outlook remaining static. This is good news for business owners – it may well not be a bull market, but it is neither a bear-market. Also, for Lower Middle Market companies in “Basic” industries, the multiples remained in a tight range even during the “Peak” M&A boom and are expected to be in that range for the foreseeable future.
Interest Rate Stabilization:
The bulk of the interest rate increase to combat rising inflation has been completed. Interest rates may continue to rise a little but are largely expected to stabilize during the later half of 2023. This will provide more certainty with debt financing – a key component in all M&A transactions.
Based on our years of experience, there is always a demand for well-run businesses in any market environment. Also, as the age-old adage goes “you can never time the market”, the same holds true in M&A. M&A transactions from inception to close typically take 9 to 15 months. Economic, market and internal company conditions can change for better or worse during that time. This is where an experienced M&A advisor can guide you through the process.
If you are considering selling your business, we at Distinct Capital Partners can help you navigate through this challenging environment. The Distinct Capital team will perform a high-level due-diligence and valuation, at no cost to you, to ensure you are in the best position to sell your business.
If you are interested in learning more, please contact Gerard De Souza, Managing Director – Business Development at GDeSouza@distinctcapitalpartners.com or our general enquiry email at info@distinctcapitalpartners.com.
