Forging a Cautious Path: Maintaining M&A Momentum in Challenging Times

PE investment committees are underwriting recession cases and raising the bar on diligence and asset quality, while sellers are hesitant to bring businesses to market in an uncertain pricing environment.

Despite these challenges, we observe continued success for select private company M&A transactions at compelling valuations. In these instances, we point to a handful of key business characteristics and process considerations that are driving optimal outcomes with both private equity and corporate acquirers.

Recurring Revenue Business Models

Strong revenue visibility and margin sustainability are increasingly critical for buyers in the face of near-term economic uncertainty. Due to the asymmetrical risk that private equity firms assume in the early stages of a hold period (where a performance misstep out of the gate is very challenging to recover from), businesses with long-term, contractual client arrangements afford buyers more comfort in bridging forward-looking earnings projections and de-risking their investments. Recurring revenue business models have long garnered the highest valuations and been the most sought after across the private equity community. Now, these revenue models are as important for risk mitigation as they are for value maximization.

Tech as a Core Principle

Digital transformation and technology-enablement trends are front and center for investors across a range of sectors and end markets. For services businesses in particular, technology is no longer a “nice-to-have.” It is now a critical component of core business functionality and client-facing service delivery models.

We’ve seen continued strength in the M&A market for businesses that demonstrate strong, highly functional adoption of technology, as well as businesses that provide consultative digital transformation services to enterprise and SMB clients.

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Visionary Leadership

Executive leadership is more important than ever, as private equity firms place greater value on backing high-performing, vision-centric management teams with long-term corporate strategies and deep benches of talent.

Operational competency and execution alone are not enough for businesses looking to achieve premium outcomes. PE buyers are requiring CEOs who can effectively articulate and execute a strategic vision to build conviction and transact at higher valuations in the current uncertain macro environment.

Growth vs. Platform

The “platform” transaction is a well-trodden path in the private equity playbook. Businesses positioned as platforms with clear opportunities for aggressive add-on M&A historically garner premium valuations with PE buyers—growth via add-ons often supersedes organic growth on the priority list.

While we don’t expect that fundamental strategy to dissipate anytime soon, we are seeing a shift toward buyers prioritizing organic growth and placing a premium on businesses that can meet performance expectations regardless of their acquisition pipeline. A sound organic growth strategy backed up by historical performance is a key value driver even for platform investments today.

Financing Is Key

When the public equity markets faltered earlier this year, the debt markets were quick to follow. After nearly two years of widely available credit with low rates and all-time high leverage levels, financing is now a key area of consideration—and often concern—for any contemplated M&A transaction.

While certainty of financing is often difficult to achieve in the earlier stages of a process, anything that can be done to mitigate this concern will help drive optimal transaction outcomes. Staple financings have historically brought a high degree of certainty to a process; however, financing sources are having a harder time providing and maintaining constructive terms in light of market fluctuations and macroeconomic challenges.

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In many instances, the most successful transactions are benefiting from supportive incumbent lenders willing to engage with prospective buyers early and support a change of control transaction. We believe M&A processes that can take advantage of those lender dynamics will achieve better overall transaction execution and benefit from greater certainty of outcome.

A Well-Designed Process

Over the last several years, private equity has increasingly sought to develop proprietary and advantaged angles and connectivity into sectors and businesses well in advance of sale processes. Now more than ever, it is critical that M&A advisors design processes to take advantage of these dynamics. Identifying the highest probability buyers—those with vetted angles and a path to winning—and targeting them early with diligence packages, access to management and third-party reports can strengthen the overall health of a process and often yield value-maximizing results.

It is important, however, to seek early price discovery with potentially preemptive buyers and to maintain workflow momentum throughout key points in the process. Through the balance of the year, we believe high-quality assets will more frequently approach a small handful of well-qualified prospective buyers to test the waters in advance of fully launching processes, with the option to defer broader marketing until a later date.

Cautious Optimism

The outlook for private company M&A remains strong despite near-term economic uncertainty. Private equity firms are sitting on record amounts of dry powder that need to be deployed regardless of where we sit in a cycle. Corporates continue to prioritize areas for strategic investment and aggressively pursue these areas through M&A.

While transaction volume is moderating and the valuation environment is under pressure, high-quality assets that meet key criteria continue to achieve optimal outcomes through thoughtful, well-run processes.