2022 was a year of mixed fortunes for the middle market M&A scene. While activity boomed earlier in the year, it slowed in the latter half due to geopolitical issues, inflation, rising interest rates, and supply chain instability.  

In 2022, valuations for M&A deals reached their peak, averaging 8.1x Trailing Twelve Months (TTM) Adjusted EBITDA, according to GF Data. This was a significant increase from the 7.4x market average for all of 2021. Meanwhile, the number of transactions in 2022 began to fall in line with pre-COVID levels. 

Here is a quick look at the last six periods for the lower middle market:

Looking ahead to 2023, most M&A professionals expect uncertainty to continue as the market grapples with the effects of rising rates and a reshaped political landscape. Guidance for the year ahead will focus on the public markets and the higher end of the private market. However, the lower middle market, including family businesses and first-time sellers, is expected to remain active.

These sectors have faced numerous challenges over the past 15 years, including the 2008 financial crisis, the COVID-19 pandemic, and various supply chain and employee retention issues. Many small business owners are tired and either retiring or looking for new opportunities. Many private equity investors have ample cash reserves and are seeking quality companies to acquire. As a result, the lower middle market is expected to have a healthy deal flow in 2023. However, buyers report seeing more favorable transaction terms and longer closing timelines, indicating that sell-side leverage is decreasing.

Rising interest rates in 2022 put pressure on lending for transactions in the upper middle market (i.e., $2B+). There is concern that this trend could spread to the lower middle market. For now, debt for transactions in the lower middle market appears stable. The market, however, will continue to be influenced by the Federal Reserve in 2023. The continued upward rate increase could quickly impact deal activity at the middle market’s upper and lower levels.

Trends that have persisted during the COVID-19 pandemic, such as growth in the distribution, home improvement, and outdoor products sectors, are expected to continue. Companies in these sectors will be looking to capitalize on their growth while the opportunity still exists. The following chart shows middle-market transaction values for select business categories.

It’s important to note that each category will react differently to the macroeconomic environment, and M&A is ultimately company-specific. Profitable companies in attractive sectors will easily transact at higher valuations than lower-quality companies.

While uncertainties are sure to persist into 2023 and M&A markets may slow, quality companies should continue to find interest in the market. 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 2023 kicks off, 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 Capital Advisor.