Nixon Peabody welcomed a panel of private equity, mergers and acquisitions, and investment banking experts to weigh in on current trends and opportunities in middle-market M&A. The panel featured Jeremy Hitchcock of the Orbit Group, Robert Menn of Gemini Investors, Chris Nicholas of Shields & Company, and Ken Seastrand of RSM US and was moderated by Nixon Peabody corporate partners Greg O’Shaughnessy and Phil Taub.
State of the Current M&A Market
In light of the unprecedented 10+ year run of successful activity in middle-market M&A—and looming uncertainty arising from record inflation, a bevy of interest rate hikes, and continued supply-chain disruptions—our panel kicked off by discussing their views on the current state of the market. The unanimous take was that waters are “choppy” as the market attempts to digest the impact of rising rates, international unrest, and a reshaped political landscape.
Our speakers project that family businesses and first-time sellers will remain active sectors of the lower middle market going forward. 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. Many continue to seek exit events so as not to “lose out” on the strength of recent acquisition activity. Institutional investors continue to hold significant dry powder and are actively looking for acquisition opportunities to deploy it. As a result, lower middle-market deal flow and opportunity remain strong—if not growing—notwithstanding the extraordinary amount of deal activity seen in 2021. But, buyers are now beginning to see more favorable transaction terms and longer closing timelines, indicating that sell-side leverage is starting to wane.
Hiring C-suite talent remains a concern for middle-market operators; long-term hiring remains difficult. PE (private equity) buyers continue to question who will run their portfolio companies, considering sellers are increasingly handing over the reins after closing. While many buyers will rely on intracompany talent, some are passing on otherwise worthwhile acquisition opportunities if the target will not have key operators in place post-closing.
The Impact of Rising Interest Rates
As interest rates increased dramatically in 2022, lending for transactions in the upper middle market (in the $2-5 billion range) sharply decreased. There is concern that this trend could bleed into the middle and lower segments of the middle market. At present, however, market debt for transactions under $1 billion remains stable (albeit more expensive). Rate increases are also impacting business owners in real time, a generation of whom have had little need to account for significant interest costs while managing their books. Rate stabilization from the Federal Reserve will be the key indicator for debt market movement in 2023.
The Results of the 2022 Midterm Elections
Our speakers did not view substantial market shifts arising from the results of the congressional midterm elections. With Democrats retaining the Senate and Republicans taking control of the House of Representatives, a split Congress could result in fewer significant regulatory changes over the next two years, bringing stability and predictability to market operators.
Acquisition activity around market sectors that thrived during the COVID-19 pandemic is expected. For example, distributors, staffing agencies, and businesses focusing on outdoor products have had significant run-ups over the past 2+ years. Those businesses will be looking to capitalize on their growth, though certain of our panelists are concerned that their enlarged valuations will not be sustainable for long as the pandemic wanes.
The recent wave of high-profile layoffs in the tech sector may be a harbinger of things to come for many middle-market operators. Bloated pandemic hiring likely will correct, which could flood the labor market with new candidates.
Finally, our panelists are beginning to see the supply chain moving from “just in time” to “just in case.” Inventories are increasing as higher operating costs lead to higher prices and suppression of consumer demand. Inventory-reliant market participants may need to quickly shift from having “too little” inventory to “too much.”