Investors See a Turning Point for M&A

Summer is usually a quieter time in the dealmaking world, as investors and advisors often head off for vacations. This year, the first half of 2023 was especially slow for M&A because of a variety of clouds in the market. While those clouds persist—interest rates are high, geopolitical conflicts are on the rise and debt capital isn’t as readily available for deals—investors are getting used to making things work in a persistently challenging environment.

“It feels like the entire private equity community decided that post-Labor Day is when everyone was getting back to work,” said Justine Chiou, managing director at William Blair, speaking at ACG Chicago‘s Closing the Deal: Latest Trends in Deal Execution and Financing panel on October 5. She and other panelists said investors can’t sit on the sidelines forever, the pressure to return capital to LPs is rising and dry powder needs to be deployed.

“The advisors are brightly advising the owners of high-quality assets that now is a good time [to sell], particularly in this window,” said Evan Palenschat, a partner at law firm Proskauer. “Now that people feel like they know what the Fed is doing within a certain band, there’s a lot less uncertainty there.”

“I think folks have come to terms with the fact that interest rates are here to stay and the earliest decline will probably be in the second half of 2024,” said Dev Vallabhaneni, managing director at lending firm Antares Capital. “It seems like everybody took the first six-to-nine months to figure out what they wanted to do for the next 12-to-18 months,” she added. “So those processes that are actually finding a buyer now are ones with sponsors that had a well-thought-out investment thesis, an executive in play and all of that coming together.”

Under Pressure

One of the reasons private equity firms are getting more active is because LPs are increasingly pressuring them to exit their long-held portfolio companies and return capital. “We talk to all of our private equity clients and ask, ‘what’s the most top of mind?’ And they would unilaterally say, returning capital to LPs,” said William Blair’s Chiou. “But no one is saying we really need to put capital to work, so there is this big structural imbalance.”

We talk to all of our private equity clients and ask, ‘what’s the most top of mind?’ And they would unilaterally say, returning capital to LPs.’

Justine Chiou

William Blair

Steve Greisemer, partner at lower middle-market private equity firm May River Capital, agreed: “There’s pressure from LPs for GPs or return capital, but we haven’t seen the pressure from them to deploy capital because the LPs are no fools and they understand that the market is tough right now and a lot of businesses are struggling,”

LPs often want their private equity managers to sell their positions and liquidate a fund before starting to raise capital for a new fund. Though some GPs are finding the fundraising arena difficult now too.

“We’ve heard that there’s 40 first-time funds in market today and 18 of those are interested in the industrial space where we play,” said Greisemer. “I think it will be interesting to see how many of those get funded because of the difficulty in closing transactions. I think the first-time funds and even subsequent funds are struggling in this market today.”

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“One pocket where that’s been different has been really specialized funds,” said Chiou, who oversees the education sector for William Blair. “In my sector, there are a couple of education specialists that have done a great job with their fundraising because they have a very specific point of view and a very clear thesis.”

Antares’ Vallabhaneni added that private credit funds are also seeing more interest in this environment. “Private credit has gained a lot of LP Interest because we’re at one of our best vintages of deployment, terms are better, you’re at a lower loan-to-value,” she said.

The Valuation Question

Because of high interest rates and lower leverage, sponsors are often putting more equity into a deal or engaging minority stake investors, which M&A experts think is a net positive for companies and gives them more confidence. At the same time, seller valuation expectations are starting to come down to more normalized levels.

When working with portfolio companies on smaller add-ons, Antares’ Vallabheni said it often takes a while for these businesses to agree on valuations. “What I hear is that it took longer for family sellers to come to terms on valuations than it did for private equity, so I think it took a while for the valuation expectations to come to an equilibrium.”

May River’s Greisemer agreed: “It takes a little while for the founder and family business owners to internalize what they’re reading in The Wall Street Journal. Their views tend to be stuck for longer probably because they’re not living in deal communities, so they don’t have as much real time information.”

He and other panelists said that’s starting to change, though. “I think you saw that for a good part of the last year, but that’s softening a little bit, both in terms of the debt markets coming back and the founder- and family-owned businesses internalizing what’s going on with the broader market,” he added.

The Sale Process Climate

One trend Greisemer has noticed is the continued aggressive nature of sale processes for high-quality assets. When the market was very busy in 2021, buyers were often rushing to win auctions and close deals quickly. “In the frothy times before the Fed started raising rates, we saw a lot of really unique behavior. People running at deals and then willing to close transactions in five to eight days after signing a letter of intent,” Greisemer said. He added that this unusual tactic has declined since the market softened, but is still alive today in auctions for high-quality assets. This has essentially changed the game and forced firms who don’t act as quickly to react. “The one continuing aspect is that deals for high-quality assets are going to happen faster and that’s going to put pressure on the deal community writ large to react to that because that’s just how you have to compete,” Greisemer added.

Strategic investors, who often have to go through more checks and balances before closing a deal, could be left in the dust in this environment. “The strategics are having to react because they’re just losing badly to the private equity firms. Even if they’re ahead on value, they’re losing by months,” Greisemer said.

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On the other end of the spectrum, investors have seen a lot of hung deals, stalled or paused processes and situations where sponsors or lenders walked away without much notice. Sponsors often check in with lenders through an auction process about leverage reads and to get a sense for who might finance the deal. But in some cases, sponsors or lenders are “ghosting” each other mid-process, according to Proskauer’s Palenschat, who advises lenders on financing buyouts and other debt transactions.

“Sometimes we get a little bit of a cat-and-mouse game on the debt side because we’re not exactly sure what’s happening on the equity side, what the negotiations are, how far along they are,” he said. “So from the debt perspective, you might be all the way there on a deal, and then all of a sudden it’s just gone.”

At the same time, sponsors often have to use new lenders these days to finance deals and sometimes find that they’ve disappeared. “Given the new players in the market or new relationships with lenders, you might be running really hard at a deal as a sponsor and then your lender just drops off,” Palenschat said. “That’s never happened a few years ago.”