Aldrich Capital Middle Market M&A Update—Second Quarter 2022

Despite widespread uncertainty, mergers and acquisitions (M&A) kept pace in Q2. Strategic buyers and private equity (PE) firms sought to take advantage of market volatility to find attractive growth prospects from companies that are cyclically—but not secularly—under pressure.   

Q2 data reveals activity is in line with recent quarterly M&A trends, albeit slightly lower than Q1 activity, despite the severe disruptions within the US economy. Supply-chain disruptions and government stimulus have continued to create enormous market disequilibrium as demand spikes and supply decreases.  

In the wake of inflationary pressure, federal fund rates increased by 75 basis points, significantly increasing the cost of debt and raising the Consumer Price Index (CPI) by 9.1% as of June 2022.  

This macroeconomic environment has been unfavorable to many business sectors as higher interest rates, coupled with economic uncertainty, pushed company valuations lower. Moreover, with governments prioritizing price stability, significant interest rate hikes could push the market into a recession and further stifle M&A activity.   

Despite the economic situation, opportunities exist for patient, strategic buyers and PE firms as previously exaggerated valuations during strong market growth periods return to reasonable or discounted values. Private equity deals are strong relative to historical standards, completing over 4000 deals worth more than $400 billion. These deals include completions of terms agreed in 2021, but as private equity coffers build up during difficult economic times, PE is eager to broker new deals.

The specter of inflation continues to dampen valuation expectations. Following a 75-basis point increase in June, many wonder if the US Federal Reserve will continue to follow a similar path. As discussed last quarter, higher rates can dampen the markets, as the subsequent increase in the discount rate can lower company valuations.   

Such volatile and uncertain economic conditions, coupled with investor uncertainty and low valuations, make for more difficult decision-making for all market participants. Discovering how to perform well under these conditions and retain value is the best method for making your business stand out to investors with cash to spend.  

However, some areas of the market continue to shine. One such sector, and one increasingly attractive to buyers, is the home service sector. Companies that focus on home improvement got a big boost in the early days of the pandemic when lockdowns forced us to stay put. Likewise, the uncertain economy is motivating consumers to ensure they’re maximizing their homes’ value.  

Service providers that help people maintain, repair, and improve their homes are receiving a lot of interest from private equity buyers this year. From roofing contractors and plumbers to pest control and landscapers, investors are increasingly drawn to businesses that provide services to homeowners and maintain consistent cash flow.   

Taking a peek at reported multiples for middle-market companies, deals continued to average ~7.5x EBITDA, in-line with prior quarters. While key business categories have seen a slight decline in EBITDA multiples over the first six months of 2022, some sectors, such as manufacturing, experienced an expansion. The desire to find and attract quality companies with better-than-average growth and margins has investors still willing to pay premiums. 

Showing meaningful performance trends to the market is critical to maximizing value upon a sale. Establishing these trends will take time. For those business owners contemplating a transaction over the next several years, failing to plan early may mean significant value left behind. 

As we head into the second half of the year, if you have any questions regarding the trends specific to your industry or need help preparing for an eventual ownership transition, fill out the form below to connect with author and expert, Brian Andreosky, CEPA.