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North American merger and acquisition (M&A) deal volumes slowed down in first quarter 2022 after a record-setting 2021. Year-over-year deal volume decreased 11.5% over first quarter 2021. Deal activity, nevertheless, was still in line with that of the last five years. With strong corporate balance sheets and record private equity (PE) dry powder

Expect M&A Deal Volume in 2022 to Be at Pre-Covid Levels

North American merger and acquisition (M&A) deal volumes slowed down in first quarter 2022 after a record-setting 2021. Year-over-year deal volume decreased 11.5% over first quarter 2021. Deal activity, nevertheless, was still in line with that of the last five years. With strong corporate balance sheets and record private equity (PE) dry powder

M&A Middle Market Update Q1 2022

North American merger and acquisition (M&A) deal volumes slowed down in first quarter 2022 after a record-setting 2021. Year-over-year deal volume decreased 11.5% over first quarter 2021. Deal activity, nevertheless, was still in line with that of the last five years. With strong corporate balance sheets and record private equity (PE) dry powder

M&A Middle Market Q4 2021 Update

M&A Deal Activity Reached Historical Highs in 2021

North American mergers and acquisitions (M&A) deal volume hit a record high in Q4 2021 reaching over 4,400 transactions. Total 2021 deal volume of 16,718 was also a record high and a 25% increase over 2020. With easy access to capital, low interest rates, and a recovering economy, M&A globally set a new record with over $5 trillion in transaction value. The U.S. deal market’s performance was particularly prominent, accounting for $2.9 trillion in transaction value in 2021, up 55% from $1.9 trillion in 2020. The U.S. deal activity was also bolstered with sellers concerned over potential increases in capital gain tax rates and 2020 deals pushed into 2021 due to COVID.

2021 was also a banner year for the private equity (PE) industry. U.S. PEs closed 8,624 deals for a combined value of $1.2 trillion, over 50% above the previous annual record for deal value. In 2021, U.S. PEs raised over $300 billion in new capital, as institutional investors increased their alternative asset class investment percentage. 2021 was also a record year for PE-backed exits. PEs exited U.S. companies with a total enterprise value in excess of $800 billion.

The venture capital (VC) market continued at a break-neck pace throughout Q4 2021. Globally, venture capital financings set a record in 2021 with $621 billion in combined deals, more than double the $294 billion recorded in 2020. Venture capital dealmaking in the United States reached an all-time high in 2021 at nearly $330 billion, buoyed by excess liquidity and an accommodative monetary policy. It was also the best year on record for U.S. VC fundraising, which hit $128.3 billion across 730 funds. U.S. VC-backed companies going public or being bought out led to exits worth $774.1 billion in 2021, nearly 88% of which was realized through public listings. In addition to the U.S. IPO market, special purpose acquisition companies (SPAC) offered a viable alternative to traditional IPOs despite tightening regulatory scrutiny.

Closed M&A Deals in North America (Q1 2019 – Q4 2021)

Record Dry Powder and Corporate Cash Continue to Drive M&A Activity

In addition to 2021 being a record year for PE fundraising and capital deployment, global PE dry powder ended 2021 at $2.3 trillion, 14% higher than the start of the year, signaling another favorable year for M&A in 2022. As of June 30, 2021, U.S. PE had an all-time high in capital overhang of $827 billion.

US PE Capital Overhand ($B)

Cash on the balance sheets of nonfinancial companies in the S&P500 swelled to over $2.0 trillion, compared to $1.5 trillion before the pandemic crisis in early 2020. Just 13 non-financial companies in the S&P 500, including tech giants such as Apple (AAPL) and Google-parent Alphabet (GOOGL), are sitting on cash and investments of more than $1 trillion, according to S&P Global Market Intelligence and MarketSmith. Cash-rich companies will continue their spending in 2022.

US Nonfinancial Corporate Balance Sheet Cash ($B)

2022 Outlook

 After a record year for M&A, dealmaking will continue to be robust in 2022. The factors that contributed to the record M&A market in 2021 will remain influential for dealmaking in 2022. Unprecedented dry powder, record levels of cash on corporate balance sheets, low cost of debt, a strong macroeconomic climate, and intense demand for technology disruption and innovation. The fierce competition among corporates and PEs will keep multiples high for sought-after assets. However, increasing interest rates during the year may soften valuation multiples.

Some headwinds such as persistent inflation, rising interest rates, supply chain and labor shortage challenges, as well as softening equity markets, may have a moderating impact on M&A transaction volume. As the market continues to be driven by these macrotrends, we are bullish on M&A activity in 2022, especially in the middle and lower middle market.

M&A Lower Middle Market Q3 2021 Update

M&A Deal Activity Continued its Record-setting Pace in Q3 2021

North American M&A deal activity remained robust in Q3 2021 following a strong H1 in 2021 and a record-breaking fourth quarter in 2020. YoY deal volume in Q3 increased 28.6% over Q3 2020. Through the first three quarters of 2021, deal volume is on pace to approximate or surpass record highs.

The economic recovery is forging ahead despite inflationary pressures and global supply chain disruption, fueling unprecedented M&A activity. M&A activity across multiple sectors is being driven by digitalization and changes in business and consumer preferences due to COVID. As businesses reopen, travel reemerges, and equity markets continue to post broad gains, corporate executives and investors remain confident in a strong economic recovery.

Although the U.S. economy slowed in Q3 2021 with real GDP increasing at a modest 2%, 2021 is on track to achieve the highest annual GDP growth rate in almost four decades. Inexpensive financing, ample private equity dry powder, strong public company valuations, and diminishing economic uncertainty continue to encourage businesses and investors to grow through acquisition.

Transaction Multiples Reached Historical High  

Average transaction multiples in Q3 2021 with Transaction Enterprise Values (TEV) of $10 million to $250 million increased to 7.6x, which was the highest quarterly mark in GF Data’s 16-year history. It again signals strong M&A momentum and transaction valuations, especially for companies that have performed well through COVID.

One of the key factors contributing to higher multiples is the greater percentage of platform acquisitions, which tend to be higher valued than add-ons. This reverses a recent trend in favor of add-on deals. From 2018 to 2020, the platform percentage of total acquisitions ranged from 79.5% in 2018 to 70.0% in 2020. For the first nine months of 2021, the figure bounced back to 74.5%.

While valuations surged across the board, larger companies tended to receive higher valuation multiples. In the $100-$250 million TEV tier, the average was 9.8x. Buyers continued to favor  companies with above-average TTM EBITDA margins and sales growth. In the past three quarters, above-average performers accounted for 62% of total reported transactions, while the historical average is 56%. These above-average performers were rewarded with a 28% valuation premium compared to below-average performers.

Debt Leverage Stabilized at Pre-COVID Levels in Q3 2021

Debt leverage has been steadily returning to pre-COVID levels since Q3 2020. Total debt in Q3 surged to 4.1x EBITDA, compared with 3.6x in Q2. The increase of leverage in Q3 is in line with increased valuation. For the first nine months of 2021, total debt averaged 3.9x, up from 3.7x in 2020 and reverted to the same level in 2019. Continued low interest rates across investment-grade and high-yield debt have boosted debt utilization to support M&A transactions.

The average debt leverage in Q3 2021 of 4.1x EBITDA comprised 3.1x senior debt and 1.0x subordinated debt, compared with 2.8x and .8x in Q2 2021, and 3.6x and .3x in Q1 2021, respectively. The lower percentage of senior debt usage reflects add-ons accounting for a lower percentage of the deals, as most add-ons are structured with all senior debt. GF Data noted that add-ons account for 24.5% of the sample transactions in YTD 2021, a drop from an unprecedented high of 30% in 2020.

Outlook

We are bullish on M&A activity during Q4 2021 and Q1 2022. The key M&A drivers remain intact, maintaining deal volumes and values at record levels. There are plenty of opportunities for value creation and growth. Highly sought-after deals that offer innovations and targets with outstanding performance are likely to continue to command a premium in this competitive market. However, recent increased COVID concerns, expected increases in interest rates and inflationary pressures could slow M&A activity at some point in 2022.

Anticipating an increase in capital gains tax in 2022, many buyers and sellers are racing to close deals in 2021. Consequently, Q4 2021 is expected to see record level of M&A volume and transaction values ahead of potential capital gains tax hikes.