M&A Trends In The Lower And Middle Markets

In the first quarter of 2022, global middle-market M&A activity maintained the momentum that we saw in 2021. Last year, lower and middle-market companies played major roles in deal-making activity. Companies of all sizes enjoyed significant buyer interest in sectors ranging from tech, transportation, healthcare, manufacturing, and logistics.

 A notable imbalance in supply and demand in the lower and middle markets has been driving up the valuations of healthy companies in hot sectors. This trend is expected to continue through 2022 for strong companies in the lower and middle markets, especially in sectors such as healthcare, cybersecurity, cloud computing, artificial intelligence, and niche manufacturing.

M&A Trends to Watch in 2022

1. Deep Pockets for Private Equity

Private equity firms had record levels of capital in 2021, and they are still flush with cash that should push deal volumes past last year’s levels in 2022. There is more than a trillion dollars out there in private equity on the buy side, and it has to go somewhere. Add-ons are a big draw for private equity, translating to more opportunities for businesses in the lower and middle markets.

2. High Valuations Driving Exits

The COVID-19 pandemic made the last couple of years challenging for many lower and middle market companies, especially those that are run by family or a sole owner. Many of these owners are coming to market earlier than originally intended after weathering the pandemic restrictions. Between this fatigue and high valuations, many owners are opting to exit their businesses to take advantage of the high prices, alongside private equity wanting to unload untapped reserves of money for high-value targets.

3. Liquidity, Debt Availability, and the Economy

Deal activity will continue to be driven by factors such as liquidity, the availability of debt, and recovering economic sentiment. Private and public markets are at ease with buy-and-build strategies and add-ons to deploy capital with lower risk.

4. Hot Activity in the TMT Sector

The tech, media and telecom (TMT) sector will continue to see fervent deal activity, especially in the B2B software space. The pandemic turned up people’s reliance on products and services provided by this sector as digitalization continues to increase. Because of the remote working revolution, investors are still taking a particular interest in enterprise software, software-as-a-service (SaaS), and cloud computing. Many larger companies are acquiring software companies that can add tech capabilities quickly instead of trying to develop these areas independently. This will continue to drive deal volume and high valuations regardless of economic factors.

5. Labor Shortages

Widespread labor shortages have remained a frustrating challenge for companies in virtually all sectors since the height of the pandemic. Filling positions and retaining talent at a time when worker expectations have changed has been difficult for many businesses. Employers are now being forced to pay workers more money while also coming up with non-monetary incentives, or operate with fewer employees (causing many owners to shoulder more of the workload, and businesses to operate for fewer hours). Companies that demonstrate strong employee retention are drawing more demand.

6. The Global Supply Chain Crisis and Inflation

The ongoing supply chain predicament has led to inflationary pressures that affect smaller and mid-size companies more than bigger players. The big corporations have more leverage with suppliers and can maintain pricing power, while the smaller players have to deal with higher commodity prices, and energy and shipping costs. This means that buyers and investors will have to be more restrained when valuing target companies.

7. Russia’s War on Ukraine

The ongoing conflict in Ukraine stands to be a potential drag on M&A activity. For now, the positive market circumstances and drivers of demand have been offsetting the precariousness of the situation. But the longer the war continues, the more risk is posed to the broader economy, leading dealmakers to pause on transactions. This is because of increasing commodity and energy costs, further disruptions to already strained supply chains, and a dreadful humanitarian toll.

8. Increasing Interest Rates

Interest rates have begun to be gradually increased, which is a factor for both buyers and sellers when it comes to EBITDA adjustments, particularly for businesses that are valued on earnings several years into the future. Companies need to adapt to protect profits and earnings from factors that could lower valuation. As long as it remains a seller’s market, M&A deals are ideal for owners’ exits to maximize wealth.

Conclusion

All in all, 2022 should continue to be a strong year for M&A in the lower and middle markets. In the US, the Build Back Better Act is something else that could open up new opportunities for M&A deals. Among the negative implications that could affect the M&A outlook this year include new COVID-19 variants, continued supply chain issues, higher inflation, stock market volatility, a potential economic slowdown in China as pandemic lockdowns drag on, and armed conflicts around the world.