Investors Brace for a Bumpy Ride

While market conditions are increasingly challenging, private equity firms and family offices will still compete for high-quality assets

The state of the M&A market heading into 2023 recalled the classic movie moment when Bette Davis, as aging Broadway diva Margo Channing, turns to her timorous friends and snarls, “Fasten your seat belts—it’s going to be a bumpy night!”

We’re not there yet.

GF Data’s completed deal data through the first nine months of 2022 featured valuations remaining elevated—actually edging to recent overall highs—on deal volume down markedly year-over-year.

The third quarter was also the first period in which successive Federal Reserve interest rate increases over the course of 2022 fully permeated senior pricing on M&A transactions. Initial senior pricing for the quarter averaged 6.5%, up nearly 200 basis points over the average for the prior period. Junior capital rates showed little comparable increase.

However, what was not yet reflected in the data was movement in debt availability, as distinguished from movement in cost. We share in the general anecdotal sense of retreat in cash flow-based lending since Labor Day.

It’s not surprising that increased borrowing costs did not dampen valuations as of late last year. Let’s imagine a $6 million EBITDA business selling for $48 million. Let’s say the deal is done with 3.5x senior and no sub debt. That’s $21 million. A 200 basis point increase in borrowing cost is $420,000 in year one. Adjusting for interest deductibility, that’s about $250,000. Whatever assumptions one chooses to make about principal repayment, the present value of the added cost is a low seven-figure amount. Not a big mover in our $48 million deal.

The “bumpy night” the market is girding itself for is the combination of an icing over of leveraged finance markets, continued signs of a coming recession, lingering inflation and sundry other macroeconomic worries.

Our year-end 2022 data will be released shortly. We can provide a sneak preview and say that by year-end, these market effects did translate into long-anticipated valuation retrenchment in selected industries.

For now, we can make these observations about the state of the M&A market, perhaps as participants reach for their seat belts:

• While deal volume is down, mid-market

M&A as a market remains extraordinarily competitive. Average purchase-price multiples reached record territory through