Recession! It’s a word that rolls off the tongue nicely but leaves a bitter aftertaste. A few weeks ago, there was momentary inversion of the 2-year and 10-year Treasury yields, which is thought to be an early indicator that an economic recession is on the horizon. On top of that, high inflation persists, the Fed is tightening money supply and raising interest rates, supply chains continue to be strained, COVID-19 is lingering, and the Russian war is causing havoc around the world. Despite those challenges, businesses continue to move forward and the companies we are currently selling are attracting significant buyer interest. But it makes one wonder, have business owners missed the opportunity to sell their company, or should those interested in selling forge ahead and continue their plans to sell their company?
Let us first address the recession. Most informed analysts agree the Fed will push the U.S. into a recession within the next twelve to twenty-four months as they try to stop inflation. But that is where the agreement stops. Some analysts think we will have a long and deep recession that hurts every area of the economy and lasts for years. Others think we will have a short and shallow recession that only touches a few economically sensitive areas of the economy and allows the other areas to flourish. Sensationalist headlines point to the former, while those doing the real work and not seeking publicity are leaning towards the latter.
Now, how does a recession impact the M&A markets? Well, they don’t help, but most of the time, when company earnings and balance sheets remain strong, they simply take a few potential buyers out of the market and thus decrease the number of deals getting done. Recessions can also have a negative impact on valuations, but for non-tech lower middle market businesses, we haven’t historically seen much impact on valuations. Finally, during a recession, buyers approach acquisitions a bit more carefully, so deals might take a little longer to complete. However, the challenges presented by a recession can be offset by a number of positive factors we are seeing in the market, including buyers who are sitting on record amounts of cash they need to invest, lenders who are eager to make loans to finance acquisitions after a very slow lending market during the pandemic, deglobalization and strategic reshoring that will strengthen the U.S. economy, and a strong consumer.
When businesses and consumers are strong, M&A activity typically continues at a steady pace. When corporations, private equity firms, and lenders are sitting on record levels of cash, M&A activity remains strong. During the COVID-19 pandemic, when much of the world was shut down, deal activity fell for a quarter or two as the U.S. had a brief recession, but then rebounded and reached record dollar volume levels in 2021. As investment bankers who make our living selling companies, the team at Waypoint doesn’t worry too much about M&A activity during a “normal” recession (the last three recessions have only lasted an average of 9.3 months). We worry more about M&A activity when there is a huge dislocation in the financial markets and banks stop lending, like during the 2008-2009 recession caused by subprime mortgages that hurt lenders worldwide. We are not expecting the upcoming recession to be caused by a financial meltdown, but rather by Fed actions aimed at taming inflation.
The chart below shows this historic number of U.S. M&A transactions completed in each year. Years in which a recession occurred have an “R” under them. As one can observe in the chart, recessions cause a slight dip in deal volume, but then volume quickly picks up and resumes its growth trend.
So how should a business owner considering the sale of their company interpret this information and plan their future? Our advice is to forge ahead with the sale process. Preparing for the sale of a company takes time. If business owners are working with an experienced investment banking firm like Waypoint Private Capital, they will work together to get the business ready for the sale and then evaluate the market. If they decide it isn’t the right time to sell, we can temporarily “put the sale on the shelf” until market conditions improve. While we wait, we can start working with the business owner on improving the value of their business (we see value improvement opportunities in EVERY company we work with). But if they get ready for the sale and the M&A markets remain strong, they can move forward with their plans to sell, and we will help them maximize the value of their business and achieve the other goals they have in the sale.
About Waypoint Private Capital
Waypoint Private Capital is an investment banking firm providing M&A, Capital Sourcing, and Exit Planning advisory services to middle-market companies throughout the country.