In December 2022, we put together LAVA’s review of 2021 and our forecasts for 2022, but who could have foreseen at that point the global macro-economic uncertainty that has overtook all of us during the year?
M&A activity remained robust in the early part of 2022 but began to slow from June as these wider issues began to bite. Below, we look back at the forecasts we made at the end of 2021 to see how many of them came true in 2022 and take a look forward at what the team thinks might be coming this year.
1. Money is still there to be had in 2023 for good businesses with excellent due diligence – Claire Davis, Partner
Predictions for 2022: Expect funding momentum, growth and creativity to soar. The market will be saturated with attractive funding options, from sector-focused private equity houses and family offices to alternative debt lenders and venture capitalists.
Reflections on 2022: Obviously the opposite has happened to some extent in the latter part of the year, with recent events reflected in the debt industry but the money from private equity is still there, even though they are more cautious about what they are investing in.
Predictions for 2023: From an investor perspective – anything regulatory or compliance driven remains interesting, particularly for the private equity houses. And they will also continue to invest in technology enabled businesses, as well as those working in business services, consultancy and ESG.
In fragmented markets, potential platforms will still attract investment as it is more appealing to have several of those businesses under one roof, benefiting from a shared cost base.
2. While there is still caution on the buy-side, things are looking more positive – Hamish Martin, Partner
Predictions for 2022: ‘Data’ is a key topic becoming prevalent in our conversations with companies, particularly around how they can monetise and seek value for their data.
Reflections on 2022: While data usage and data volumes, of course, remained important and our prediction wasn’t wrong, data obviously wasn’t as high up on the priority list as we predicted due to the wider macro-economic challenges of 2022.
This macro uncertainty, with higher inflation and the war in Ukraine leading to more expensive fuel and higher interest rates, has influenced buyers both in PE and on the trade side.
Both have been showing increased levels of caution, and market participants have been much slower to complete deals in 2022.
Acquirers are now doing more due diligence and looking for more certainty before completing.
Forecast for 2023: Cultural fit remains important, but deal completion is linked more broadly to the quality of the businesses involved and while there is still caution on the buy-side, things are looking more positive.
Inflation has peaked, or is about to, and sterling has bounced back. Interest rates also look as though they may have nearly reached the top, however they remain above historic levels so private equity investors are more likely to equity fund deals due to less available debt.
Buy and build will be less popular for the same reason, with sellers approaching private equity investors earlier in the funding cycle.
3. With some of the recent uncertainties now stabilising, the market can price in the changes that have occurred – Simon Woodcock, Partner
Predictions for 2022: Cultural fit in transactions will play a leading part in dealmaking in 2022 and investment in post-COVID culture and working practices will be fundamental for long-term success
Reflections on 2022: Businesses are now collecting the data to help understand the differences in the working environment created by flexible and homeworking, and their impact on performance and output
In the battle for talent, employers will still need to demonstrate their flexibility, and will use technology to support cultural change. However, stretching this too far is starting to detract from productivity, collaboration and creativity, and we are seeing many industries striving to find a happy medium.
LAVA holds its flexibility dear, but the team has enjoyed being in the office more in 2022 as well the opportunity that provides to bring creativity to deals, helping create better solutions.
Predictions for 2023: Uncertainty has been a major barrier to deal completion in the past year, however as some of the unpredictability is removed from the market, higher costs can be priced into transactions, and we are now seeing more stable pricing in the debt markets.
The Covid hiatus in the deals market led to a rush to complete that boosted deal volumes. Similarly in 2022, many deals have not completed in the second part of the year, so if we continue to see more stability in 2023, there is a chance that there will be a similar boost to deal volumes.
Due diligence will still be intensively pursued, and buyers will continue to proceed with caution so all parties to transactions will need to prepare for an intensive due diligence process.
4. We’ll see an increase in opportunistic M&A, particularly in the trade and PE-backed trade markets – Tom Rowe-Jones, Associate Director
Predictions for 2022: Investors and businesses won’t be afraid of, and will even be looking for, more ‘challenging’ M&A opportunities in order to gain an edge over market incumbents.
Reflections on 2022: A lot has changed since we made these predictions! It’s clear that the changing global macro-economic environment will mean that ‘challenging’ M&A opportunities may take a back seat for now
On the flip side, if organisations have embraced the levers mentioned above, there is a high chance they’ll have a competitive advantage, whether through M&A integration or internal transformation.
I think an aspect of my 2022 prediction will continue in 2023, albeit to a lesser extent than previously forecast!
If market leaders can take advantage of lower valuations (as we have seen with the volume of inbound M&A in the UK) and competitors that are relatively worse off, then the upside opportunities in M&A through transformation may even be greater over the medium to long term than they were previously.
Predictions for 2023: Possible further interest rate hikes across developed markets will mean that as firms re-finance at a greater cost of debt, there will be more focus on servicing their debt and less cash expenditure, including on M&A.
This also means the cost of financing deals in the private equity market will be higher, which could impact activity. Having said that, in the PE environment there is a lot of capital that has been raised due to the low interest environment we have had in recent history and that capital needs to be deployed.
Similarly, businesses that have shored up their balance sheets over the past few years will now see opportunities to deploy their capital at more sensible valuations so we could see an increase in M&A in some areas of the market.
This will be particularly in those sectors with defensive characteristics including compliance based professional services businesses.
Whilst these businesses don’t have the same recurring revenue models as their technology counterparts, their repeat revenue, high percentage of contracted forecast revenue, and compulsory service offering make them attractive targets. If you then throw in the chance to drive innovation through technology, then the opportunity to create superior returns becomes compelling.
5. A number of sectors will continue to see consolidation, driven by private equity funds with cash to spend – Millie Counsell, Associate
Predictions for 2022: Further challenges and opportunities will arise from fragmented niches, but the question will be whether these platforms can cope with rapid growth while still retaining the qualities that made them successful in the first place.
Reflections on 2022: The above was definitely true but has been overshadowed by all that happened last year; which was unforeseeable.
However, fragmented industries have continued to consolidate, with early years providers, professional services and managed service providers continuing to be active in this way.
Private equity investors have been less aggressive in 2022, waiting out the uncertainty in the markets, but as a result many are now sitting on funds.
Predictions for 2023: We now expect private equity to drive the whole market, not just buy and build. And in areas where they can completely underwrite the deals themselves without the need for additional debt, they will be able to progress more quickly towards completion. Where they have delayed deals due to recent uncertainty, many are now looking to create bolt-ons and move towards making an exit.
A number of sectors will again continue to see consolidation including early years providers driven by private equity backed funds at the top of the chain who are looking to build platforms. Those struggling with end game growth will acquire and create a platform, with many buy and build platforms likely to start with PE rather than debt in the first round.
As Lesley and Rob joined us in 2022, they have provided their reflections on 2022, and what is to come for 2023:
6. In 2023, we may see small business owners looking to de-risk and get some cash out of their businesses – Lesley Dorrance-King, Manager
Reflections on 2022: Nobody foresaw the shocks in the market in 2022, with interest rate rises, market uncertainty and major supply chain issues combining to create a softening of multiples across many sectors. Mortgage rate increases and related house price reductions just increased the level of uncertainty many were feeling.
We have seen a change in the nature of deals in the market with interest rate increases making it harder for trade investors, as well as buy and build becoming more difficult as acquirers don’t have a large ‘war chest’ to rely on.
Covid also continues to be a problem although the working environment has now changed, and employees are returning to the office.
Predictions for 2023: In 2023, small business owners likely to be more willing to give up some equity.
Debt providers will be stricter on covenants. so while debt will continue to be available in the right circumstances, the additional requirements may be prohibitive for some and there will be fewer buyers prepared to take a risk on a deal.
PE firms will continue to look for ESG and very tech-enabled businesses, with recurring if not repeat revenue; basically, anything with increased certainty!
But the markets are becoming increasingly aware of ‘greenwashing’ so they will be more interested in businesses that are underpinned by ESG services and solutions, than any simply presenting ESG credentials.
Businesses promoting an ESG strategy as part of their positioning may be less prepared to define themselves wholly around that story and will need to ensure it is entirely credible in order to do so.
7. Disruption always breeds opportunity and there are opportunities for those who are able to remain nimble – Rob Telkman, Associate Director
Reflections on 2022: Having started early in 2022 intrigued by LAVA’s approach to M&A, I have seen first-hand the importance of our approach of getting to an initial view on deal parameters quickly, without an onerous time burden on the target business.
Buyers are no longer prepared to give things a try and if in doubt, will move on, so getting that early perspective on the potential attractiveness of a deal is hugely valuable.
Another issue we have seen during 2022 is the continued increase in fixed costs – which haven’t come down again. Many people thought this was a temporary, Covid-related issue but that hasn’t been the case. Rising costs have made acquirers increasingly hesitant, providing an additional layer of uncertainty, particularly where the cost base is not fixed contractually.
Predictions for 2023: Moving forward into 2023, the hangover from high levels of economic uncertainty means it is likely to remain a challenging deal environment, at least in the short term.
I suspect that inflation will remain high for much longer than the market currently anticipates, and markets may become more volatile, however interest rates may not go as high as some expect, and therefore rates are likely to remain negative (in real terms) for the foreseeable future.
The focus of investors will be on businesses with enough pricing power to protect margins and high levels of current (cash) profitability and less on unproven future growth potential.
However, disruption always breeds opportunity: There will always be investment and there are opportunities for those who are able to remain nimble and keep enough powder dry. It will also be increasingly important for vendors to have robust forecasting models and be prepared for more intense due diligence.