Aldrich Capital Middle Market M&A Update–Second Quarter 2023

During the second quarter of 2023, the M&A market remained active, though it faced some challenges due to economic uncertainties and increasing interest rates. These factors led to fewer deals and overall lower price levels for acquisitions. However, plenty of capital was still available, keeping the market alive and kicking—even if the volume of deals was somewhat reduced.

Amid it all, strategic acquirers took center stage in the middle-market M&A scene, making up a whopping 89.5% of all deals, the second-highest level of strategic activity in five quarters. On the other hand, financial buyers, like private equity firms, represented the remaining 10.5% of deals.

Despite the challenges, it’s evident that the M&A world remained dynamic. Strategic players were actively seeking opportunities, and with plenty of capital at hand, private equity buyers stood ready to make deals when the opportunity arose.

Overall, it’s clear that businesses and investors remained cautiously proactive amid the economic uncertainties and rising interest rates, which kept the M&A landscape in the lower-middle to middle-market interesting and moving.

Distribution of market share by sector for Q2 2023 in deal activity resembled that of Q2 2022, with one notable change: the Financials sector significantly increased its share. Consumer Discretionary, which was the dominant sector in Q2 2022, saw a decline to 12% in Q2 2023, ceding its position to Healthcare. Industrials, Financials, and Information Technology each made up 13-16% of the activity, followed by Consumer Discretionary at 12%.

Over the past year, several noteworthy trends have emerged. Consumer Discretionary deal activity decreased by 6%, while Financials and Healthcare experienced significant upticks, gaining 2-4% in overall deal percentages. Each sector faced unique impacts from external factors such as interest rate fluctuations, global economic conditions, trade disputes, political challenges, pandemic-related supply chain issues, and evolving governmental policies.

As noted in the graph below, middle-market transaction values have dipped slightly across business categories. However, many quality businesses in the lower-middle market have kept pace with multiples paid over the last several years by buyers. Simply said, if you are growing, have better margins than your industry, and can continue to scale, buyers will continue to pay up!

Amid economic changes like rising inflation and interest rates, private equity investors are finding creative ways to invest the large amounts of cash on hand, aka. dry powder. They are focusing more on “add-on acquisitions” as a strategy to navigate the uncertain financial climate.

Add-on acquisitions refer to smaller deals that are added to existing investments. They have become increasingly popular, making up about 80% of all buyout transactions in the US during the first quarter of 2023, up from around 68% before the COVID-19 pandemic in 2019.

Why are these add-on acquisitions catching on? Well, they offer several advantages. First, they are easier to finance, which is essential in the current constrained lending markets. Second, these smaller deals can bring additional growth to the companies, making it a win-win for investors and the businesses they support. Plus, by building upon proven strategies from existing investments, they avoid some of the risks and expenses that come with starting entirely new ventures.

The appeal of add-on acquisitions is expected to stay strong, even as interest rates find a “new normal.” They are considered lower-risk investments with the potential for attractive returns.

Overall, this approach seems to be gaining popularity as investors seek smart ways to deploy their resources and make the most of the changing economic landscape.

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 leaving significant value behind.

If you have any questions regarding the trends specific to your industry or need help preparing for an eventual ownership transition, please reach out to your Aldrich advisor.