Top M&A Challenges Facing Entrepreneurs in 2023

Top M&A Challenges Facing Entrepreneurs in 2023

Where Are We In the Current M&A Cycle?

Despite headlines suggesting a slowdown, better metrics are needed to paint an accurate picture of what is actually happening in the lower middle market (LMM). While reporting suggests that there’s been a drastic decrease in activity in M&A, this reflects a drop-off in larger deals in the bulge bracket of large, multinational investment banks. There is more public data on these deals and as a result, does not reflect the lower middle and middle market segments, which have shown incredible resilience and are primed for a strong Q4 and what’s shaping up to be a robust 2024. 

While it’s true to say that headwinds have impacted M&A in 2023, the lower middle and middle market segments have continued to shrug off disruptions caused by interest rate increases, supply chain challenges, geopolitical unrest and the lingering effects of Covid-era dealmaking

Private Equity Activity & M&A

With 2021 and 2022 reaching historic deal volumes as a result of cheap – almost free – debt, it’s easy to mislabel the pullback in 2023 looking too narrowly at certain performance data. 

In Q2 of 2022, interest rates started to creep up as the Fed hoped to cool down what was a white-hot inflationary market. Looking back a little further, we see that while this was the beginning of a visible decline in the bulge bracket, the lower middle and middle markets remained active and continued to attract investors seeking good deals with quality organizations.

Not only have these segments remained strong –  with steady activity – there is still plenty of cash that private equity needs to put to work. 

What Should We Expect From Valuations?

As business prospects improve and valuations reset to pre-pandemic levels, lower middle-market and middle-market companies have become more attractive to investors. These smaller, strategic targets are often perceived as having substantial growth potential in terms of scale and operations. There has only been a slight decrease in multiples for smaller transactions and a missing piece of this puzzle is that data is often excluded from strategic activity. 

Lenders are still eager to offer financing in the active lower middle market and buyers are now directing their attention towards LMM opportunities, where lenders are still capable of facilitating deals. Following a remarkable surge in deal activity in 2021, the initial six months of 2023 have showcased enthusiasm and heightened transaction engagement within lower and middle-market companies. 

Adaptable M&A Strategy: Growth and Competitive Edge Amid Shifting Markets

M&A continues to be an essential strategy for companies seeking growth and a practical route to gaining a competitive advantage that responds to changing market conditions. The appetite for M&A has remained healthy as acquirers have shifted focus to smaller businesses. While companies in the lower and lower middle markets continue to remain appetizing to buyers, challenges do remain. 

Challenges Facing The Lower Middle & Middle Markets

The lower middle market faces unique challenges in M&A transactions, including limited access to capital, competition from strategic buyers, valuation and pricing pressures, lack of professional advisory support, talent retention and transition issues, regulatory complexities, scalability constraints, and information asymmetry. 

  • Limited Access to Capital

For lower-middle market companies, the struggle to access the necessary capital to fund M&A activities remains challenging. Traditional lenders and financial institutions may be hesitant to extend credit or provide financing due to perceived higher risks associated with smaller companies. However, larger companies are taking advantage of this opportunity to realign their strategic targets and scoop up smaller, well-run companies.  

  • Competition from Strategic Buyers

Lower middle market companies face intense competition from strategic buyers, larger corporations seeking acquisitions to expand their market reach, capabilities, or product portfolio. Strategic buyers often have more financial resources, industry expertise, and established networks, giving them a competitive advantage when pursuing attractive acquisition targets.

  • Valuation and Pricing Pressures

Valuation and pricing challenges persist in the lower middle market segment. Determining the fair value of a company can be complex, particularly when financial data and performance metrics may not be as comprehensive or readily available as they are for larger enterprises. The valuation gap between buyer and seller expectations can lead to stalled negotiations and difficulties in reaching mutually beneficial agreements.

  • Talent Retention and Transition

Employee retention and management transition can be complex in the lower middle market. When smaller companies are acquired, the integration process can disrupt the existing workforce, leading to potential talent attrition. Additionally, management succession planning may be lacking, making it challenging for the company to ensure a smooth transition of leadership during and after the M&A transaction.

  • Lack of Scalability and Infrastructure

Some lower middle market companies may lack the scalability and infrastructure necessary to support rapid growth or integration into a larger organization. Inadequate systems, processes, and technology can hinder the smooth integration of operations and limit the potential synergies that could be achieved through the M&A transaction.

  • Due Diligence and Information Asymmetry

Due diligence is crucial in M&A transactions to assess risks, uncover potential liabilities, and validate financial and operational information. However, lower middle market companies may face challenges in providing comprehensive due diligence materials or accessing the same level of information about potential targets. Information asymmetry can create uncertainties and increase perceived risks for buyers, potentially impacting deal negotiations.

Overcoming these challenges requires strategic planning, specialized expertise, and a deep understanding of lower-middle market dynamics. Despite these hurdles, successful M&A transactions in this segment can unlock growth opportunities, facilitate industry consolidation, and drive value creation for both buyers and sellers.

How to Navigate Current Market Challenges

With the support of a strong M&A advisory team, buyers and sellers can unlock opportunities, make informed decisions, and prioritize acquisitions that align with investment criteria and business priorities.

Above all, as your M&A advisory team, REAG can help entrepreneurs navigate complex transactions, optimize valuations, and ensure a smoother and more successful M&A process by communicating clearly and effectively throughout our work together.

If you are ready for the next chapter of your entrepreneurial journey, reach out and let’s begin together.