Dealmakers Optimistic About 2023’s Second Half

Much like the viral optical illusion of 2015, when the online community was sharply divided on the color of a dress, the health of today’s M&A market is in the eye of the beholder.

“If you looked at it one way, some people would see a blue dress; if they looked at it the other way, some would see a gold dress,” said Bob Dunn, managing director of GF Data, recalling the so-called #TheDress meme during a panel at ACG’s recent DealMAX conference. “That’s pretty much what the first quarter looked like.”

Dunn was among the speakers on the “M&A Market Update” panel on Monday, May 8, sponsored by Insperity, which explored the types of transactions moving ahead today, what it takes to win deals in this environment and the outlook for middle-market M&A in the second half of the year.

The market continues to show mixed signals. On a positive note, deal pricing gained strength at the start of the year. Data from GF, an ACG company that tracks deals between $10 million to $500 million of enterprise value, showed the average purchase price multiple rebounding in the first quarter to 8.1x trailing 12 months EBITDA, up from 6.9x in Q4 2022. A closer look at the data, however, reveals a “story of the haves and have-nots,” Dunn noted, where high-performing companies attracted strong multiples, while across the rest of the field, “there were some holdover deals that were maybe delayed or renegotiated after the letter of intent had been signed.”

On the other hand, the cost of capital is rising, posing a headwind for dealmakers. GF’s data shows average senior debt rates rose to 8.1%, up from 6.7% in Q4 2022 and 4.6% in Q1 2022. That pricing reflects deals tracked by GF with $10 million to $250 million of total enterprise value.

Shaping Deals

Together, these forces have created an environment where transactions continue to move forward but with some key differences from years past.

Steve Higgins, managing director at middle-market M&A advisory firm Delancey Street Partners, noted that his phone is still ringing, albeit with different calls than he received 18 months ago. Today, strategic acquirers or private equity-backed portfolio companies are approaching his firm about one-off negotiations, he said. At the same time, companies that began exploring a sale last year but stalled with a softening market are now testing the waters again.

Add-ons are always kind of the fallback when the market is down.

Dyana Baurley

MiddleGround Capital

The rising cost of capital has contributed to an emphasis on smaller deals, added Dyana Baurley, a director at private equity firm MiddleGround Capital who leads North American business development. “Add-ons are always kind of the fallback when the market is down,” she said.

Headquartered in Lexington, Kentucky, MiddleGround focuses on industrial manufacturing businesses in the lower middle market, where Baurley noted the macroeconomic environment plays less of a role in an owner’s decision to sell: “Fundamentally, family- and founder-owned businesses are going to trade regardless of market condition. …They want to do estate planning; they have different needs, so timing the market isn’t necessarily priority No. 1.”

Restructuring engagements are also picking up after a light few years in response to stress in the markets, noted Bruce Goldstein, a managing director at BDO, who works in the firm’s restructuring and advisory practice. Echoing GF’s findings that deal multiples are rising, Goldstein says he’s “amazed” at some of the prices he’s seen opportunistic investors pay, noting the potential role of ample dry powder in driving up prices. Private capital dry powder is estimated by Bain & Co. to have reached $3.7 trillion at the end of 2022.

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Still, the pace of deals has remained down, even as investment bankers’ backlogs are rumored to be building. As for when those companies will come to market, the jury’s still out. Timelines continue to be pushed to a later date, noted Baurley. MiddleGround is “very optimistic about the rest of this year as well into next year,” she said. “Most of our investment banking relationships and overall deal sourcing relationships have higher backlogs than they had in 2021, which was coming out of COVID.”

Still, Baurley doesn’t expect the “landslide of deals,” that followed the pandemic, predicting a “slower trickle” instead. She anticipates that will materialize after the first big successful sale process, which will in turn prompt other companies to enter the fray.

Gaining an Edge

When a company is preparing for a sale, HR considerations have become increasingly urgent, noted Emily Hak, managing director for private capital markets at Insperity and the panel’s moderator. “When I started at Insperity nine years ago and I was talking to different capital partners, they were like, ‘Emily, you’re barking up the wrong tree. HR doesn’t come up in our board meetings,’” she recalled. “Now, I’m hearing that every board meeting is (discussing) turnover reduction, compensation analysis.”

Attention to human resources issues, corporate culture considerations and retention are all top of mind for advisors as they prepare their clients for a successful sale.

On the other side of the table, buyers are also eager to gain an edge, so what can they do to win out against their competition in today’s market?

“The obvious answer is just pay more,” said Higgins.

Beyond writing the largest check, however, there are other ways that buyers can gain an edge, he adds.

Higgins recommended that private equity funds come to management presentations well-informed about the company’s industry, a gesture that will impress both the banker and the management team. “I want private equity funds that are going to help me look good in front of my client,” he said. “I want that management team, after the meeting, to say, ‘Oh yeah, these folks really know what they’re doing.’”

When it comes time to submit an indication of interest, firms that have done their homework and spent time speaking with the investment banking team will have a leg up over a competitor that emerges out of the blue. “I’m going to give that (IOI) much more weight than the one where I haven’t had a conversation with anyone at the fund,” Higgins said.

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That research can also help a prospective buyer better understand the seller’s motivation, added BDO’s Goldstein. Knowing what the seller is looking for, whether they want to stay involved and the catalyst for the transaction, along with what’s important to them, can help improve the odds of winning a deal. Beyond showing an understanding of the business and its industry, presenting a post-integration plan can put a seller’s mind at ease. “Especially if it’s a family business, they don’t want to see their legacy tarnished over time,” Goldstein said.

Industry specialization is another quality that can give bidders an edge. “Having some sort of angle, whether it be manufacturing-focused or having an operational focus—all of those things just help funds differentiate themselves,” Higgins said. “Also, I think it helps them bid with conviction, which allows you, at the end of the day, to just pay that premium price.”

Private equity funds should be aware that it’s not only how they present themselves in the context of a specific deal that matters. Their reputation in the market will also be scrutinized.

“When I’m going to (a management presentation) and sitting across the table from a management team, what is the first thing that they do? They’re going to Google MiddleGround Capital,” Baurley said. From how the firm presents itself in the market, to how it positions itself as a partner, to what other investment banks have said about it—all of that information can easily be found and will influence the decision of seller.

“We’re very focused on the culture internally of the investments we make,” she said. “But as private equity funds, we have to remember that they’re underwriting us.”

Katie Maloney is ACG’s content director, based in Chicago.