GRACE MATTHEWS INSIGHTS

With respect to the broader M&A market, recent headlines about declining public equity markets, inflation and international turmoil have dominated the news cycle. While overall deal volumes will be down in 2022, we also need to keep in mind that 2021 was a record year for M&A overall, in part due to the threat of tax law changes and a backlog created by a COVID-driven slowdown in 2020. Transactions have and will continue to close in 2022 because, for many companies, strong current performance and a healthy outlook have outweighed potential concerns about macroeconomic conditions. To assess buyer interest and valuation implications for potential sale processes, we believe the most important considerations pertain to how individual companies are performing, the sustainability of their current performance, and any impacts they are experiencing from current macroeconomic conditions. For some lower middle market chemicals, specialty materials and ingredients businesses, we have seen them not only adapt, but thrive. High-quality businesses that have navigated supply chain challenges, effectively responded to inflationary pressures (i.e., passed along price increases), and for whom the performance outlook (i.e., sustainability of earnings) remains healthy, continue to attract buyer attention. On the flip side, some sellers have begun to “pull” sale processes out of the market, quite often because of factors largely outside of their control. Examples include companies with significant exposure to European / Asian markets and large businesses ($500 million or greater) where buyers may rely more heavily on syndicated debt markets and CLOs that have seen meaningful tightening. 

Many potential buyers remain well-capitalized and eager to put money to work to acquire fundamentally strong and attractive businesses. U.S. private equity “dry powder” (committed capital) reached a record $1.0 trillion at the end of 2021(2), and lower middle market lenders have remained a bit more active than their larger commercial and institutional counterparts. Similarly for strategics, balance sheets remain strong, and we see them continuing to aggressively pursue bolt-on acquisitions. While there are many reasons strategics pursue M&A, a common theme we often hear is that they are willing to be disciplined so that when the “right” opportunity comes along, whether current market conditions are favorable or not, they can aggressively pursue it based on the potential long-term, strategic benefits. 

With so many moving parts both in the broader economy and for individual businesses, we recommend sellers and buyers keep a few important points in mind. First, sustainability of earnings has become perhaps the most pertinent topic that sellers, buyers and lenders need to understand. Buyers are more commonly performing and closely analyzing market studies to understand market trends and outlook. Similarly, sellers need to be prepared to support financial projections and respond to increased diligence scrutiny related to the outlook. For owners considering a sale process, time is on your side, and it is critical to use that time upfront to prepare. Prior to engaging in discussions with potential buyers, sellers should take time to proactively address potential buyer concerns, properly frame marketing materials, and get organized for the inevitable due diligence that will follow. Finally, we recommend potential sellers consider what is most important for them to achieve from a sale (e.g., value, terms, legacy, post-closing role, outcome for employees, etc.). With the goal defined, we can then work backwards to customize a process and timeline that maximizes a seller’s potential to achieve a desired outcome, while considering a variety of internal and external (market) factors.