What This (Possible) Recession Means for M&A

Inflation, rising interest rates, geopolitical conflicts, and continued supply chain constraints have taken their toll on the public markets. Many entrepreneurs are now wondering how these economic and political challenges have or will affect valuations in the private sector. The question is especially pertinent on the heels of a record year in the M&A market.

With valuations and deal volumes having reached historic highs, it’s fair to wonder if last year’s level of activity is sustainable. While we don’t have a crystal ball, we provide below various insights based on what we’re hearing from investors regarding their expectations for the M&A market.

Back (Closer) to Reality

During the height of M&A activity in 2021, competition for deals was so elevated that many investors and lenders were willing overlook certain risks in target businesses to win deals. In many cases, this meant limited or expedited due diligence periods or more favorable terms than buyers would typically concede.

Our recent conversations with investors indicate that the ground is shifting a bit. Volatility in the public market will bring a more critical eye from both investors and lenders, and recession-susceptible businesses are unlikely to command the same level of interest or valuations they did last year.

As a result, deal terms and diligence periods are likely to return to normal. This is not to say that we are transitioning to a buyer’s market yet — but the pendulum may be swinging closer to the middle.

Predictable Businesses Will Sell for Premiums

As riskier opportunities are viewed with less enthusiasm, investors believe that safer opportunities are likely to command premium attention. Among the hot commodity targets will likely be businesses with:

  • A high degree of industry predictability
  • Recurring core revenues
  • Long-term customer contracts
  • Low attribution

Contractual business services, healthcare services, and Software-as-a-Service companies with proven growth performance and customer retention are among the industries expected to receive heightened attention during a recessionary period, as investors place a premium on companies with an established moat to weather an economic downturn.

Most investors we have spoken with believe companies with solid fundamentals and a clear growth plan are unlikely to see a sharp drop in valuations. Conversely, businesses with little differentiation, as well as those with high customer acquisition costs and customer concentration, will probably see valuations and buyer interest fall during a recession.

What About Lenders?

Another pressing question — how will the rising interest rate environment impact lenders’ willingness to stretch their debt multiples in a recessionary M&A market?

Investors we have spoken to have indicated that their lender networks have remained eager to provide considerable debt for higher quality deals. One private equity investor mentioned that they are still seeing debt multiples as high as 7x EBITDA, meaning double-digit sales multiples are likely to continue, at least short term for A+ opportunities.

With that said, if inflation cannot be tempered to the Fed’s satisfaction and interest rates continue to rise at the current clip, lenders will eventually be forced to pull back on financing and increase the cost of debt to a level that will inevitably compress valuations. The impact on valuations remains to be seen.

Additionally, many private equity groups will likely be more leery to juice up leverage on acquisitions during a high interest and recessionary environment, due to the high cost of debt and the operating and financial risks that a highly leveraged acquisition can impose on a business. Conservative investors are unlikely to opt for more than 3-4x EBITDA of debt financing for acquisitions during a period of market volatility.

Deal Volume

Our conversations with investors suggest that deal volume has dipped slightly since the M&A boom that last year’s tax and valuation environment brought on, although it has remained strong relative to historical standards. One private equity group we spoke to mentioned that this year is on track to deliver the second-highest deal volume in the firm’s history, behind only 2021.

One interesting trend we are hearing about is that smaller deals (sub $2 million EBITDA) have slowed slightly, while deal volume in the lower middle market ($2+ million) has remained steady. This may be attributable to advisors pausing on smaller deals, given investors’ preference for businesses with proven scale and the ability to weather a recessionary period profitably.

Nonetheless, many factors—baby boomers reaching retirement ages, valuations remaining high in the private sector, and an unpredictable horizon for economic volatility—have pushed sellers to continue to hit the market at high volumes.

How Can Class VI Help?

We know a recession can be scary for business owners, especially entrepreneurs whose target time window for a sale is approaching. Class VI employs former operators in all segments of our business. We can work with you to position your company to thrive through challenging economic periods and come out of the other side stronger and more valuable to investors.

If you would like information about how our Pathfinder program can help you lay the groundwork for an eventual sale, we encourage you to reach out to rscott@classvipartners.com.

If you are looking to sell your business within the next 6 to 12 months, our investment banking team would welcome a conversation to learn more and determine if there is a fit. Feel free to email bmotch@classvipartners.com for an introductory conversation.


Bobby Motch  |  Head of Sponsor Coverage |  Class VI Securities, LLC

As head of Sponsor Coverage, Bobby is responsible for managing financial and strategic sponsor engagement, developing sponsor-related content, and managing Class VI’s Buyer CoPilot program. Prior to his role as Head of Sponsor Coverage, Bobby was responsible for executing and closing transactions and supporting Class VI clients through financial analysis, modeling, market outreach, industry research, and valuations.

The views expressed represent the opinion of Class VI Partners. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness.  While Class VI Partners believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and the Class VI Partners view as of the time of these statements.

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