Change is in the air for private equity (PE) firms, which closed record-setting numbers of merger and acquisition transactions in 2021 and early 2022. It’s been smooth sailing for PE firms for several years – explosive fundraising, returns that regularly outpaced those achieved in the public markets, easy access to debt financing, and low interest rates. But since mid-2022, waters have gotten choppy. Whether you are in the recession or “slowcession” camp, the economy has entered a slowdown and as a result deal volume is dropping, as are overall valuations for M&A sellers.
In the macro environment, there is stiff competition as an expanding number of PE firms have a record level of dry powder. A PwC analysis finds that the number of funds raising over $500 million nearly tripled from 37 in 2011 to 104 by 2021. And, according to PitchBook, PE firms had $1.2 trillion of dry powder in August 2022 (down from $1.5 trillion in 2020).
However, when it comes to investing all that capital there are significant headwinds and uncertainty, including ongoing supply chain issues and the war in Ukraine. Less willing lenders, rising interest rates and low unemployment levels present challenges to companies across the U.S. And PE firms, having become a considerable presence in the economy, are getting significant pressure to invest and create value in their portfolio companies via environmental, social and governance strategies.
What are the ramifications for business sellers? As a general comment, it is a more arduous process to get a PE deal done today than it might have been a few months or years ago, but M&A transactions are closing. There are several trends worth considering:
- Deal types – as bank financing becomes more costly and increasingly difficult to obtain, there are fewer all-cash leveraged buyouts; instead, add-ons, divestments, and public-to-private deals are increasingly common
- Deal structure – with less cash available up front, buyers are offering more earnouts and other contingent payout instruments to entice sellers
- Large PE firms are going down-market for smaller deals to avoid using expensive debt financing to leverage their investment
- Fewer M&A auctions, as extended due diligence becomes the norm – PE firms are taking more time to get to know the management of target acquisitions, and strong fundamentals are more important than ever. Inflation, labor costs, uncertainty … buyers are taking longer and digging deeper during due diligence in an attempt to add certainty in an uncertain environment (for an example of a spectacular fail in due diligence, read our article on Theranos).
- Lower valuations – it has been a seller’s market for years, with attractive businesses courted by multiple suitors and able to demand all-cash deals; however, it has flipped to a buyer’s market
- A focus on data – PE firms are increasingly looking to digital transformations in their portfolio companies to create value, focusing on developing and enhancing data strategies that build speed, efficiency and productivity, and thus improve profitability
Deals are taking longer. With sellers holding out for last year’s valuation and buyers offering multiples in line with current conditions, it can be difficult for the parties to reach agreement. But no matter the economic environment, the keys to success for a seller, as ever, are to prepare your company for sale well in advance, select the right PE partner, and work with a trusted team of deal professionals to help you negotiate and structure your definitive agreements. With record levels of funding at the ready, PE firms will find ways to close attractive deals.
At Linden Law Partners, we specialize in quarterbacking all aspects of M&A deals, and we’ve represented buyers and sellers in hundreds of M&A deals. While there are many common threads among the most successful transactions, we recognize the uniqueness and personal attention required for each deal. Contact us to discuss how we can help.
 PWC, Next in Private Equity, https://www.pwc.com/us/en/industries/financial-services/library/private-equity-insights.html