What factors contributed to the M&A slowdown in 2023?

While there are a number of factors that seemed to have collectively contributed to lower volumes of M&A in 2023, all of them can be reduced to one theme: uncertainty. Corporates and sponsors require confidence that engaging in M&A will deliver on their growth or investment objectives. However, uncertainty in the wider economic environment created by various economic, regulatory and geopolitical factors reduced confidence that transacting M&A would be successful.

One such driver of economic uncertainty on both sides of the Atlantic was inflation. This resulted in central banks mandating higher interest rates, which increased the cost of debt acquisition financing and also brought downward pressure on target valuations. While sellers were initially slow to reconcile themselves to lower valuations (often leading to protracted transaction timelines), towards the end of the year we did see parties reach a landing on price and move forward with transactions.

Changes to the regulatory environment which increased merger control and FDI scrutiny of transactions also likely contributed to the decline in M&A. In the U.S., for example, changes to the merger control regime dramatically increased the regulatory burden that corporates and sponsors shoulder on transactions. In addition, increased engagement by the Federal Trade Commission materially added to the risk profile for large M&A transactions.

The prospect of a change in government in both the UK and U.S. in 2024 also added to market uncertainty in 2023, a factor that will continue for much of this year.

Finally, the Israel-Gaza conflict added to the already mounting geopolitical uncertainty created following Russia’s invasion of Ukraine in 2022. While the effects of this conflict on M&A activity globally are not yet clear, the 29% dip in global M&A activity in Q1 2022 following Russia’s invasion of Ukraine gives an indication of the potential effect the Israel-Gaza conflict could have on M&A activity globally.[2]

What impact did the 2023 slowdown have on deal terms?

Whilst the above factors gave buyers more leverage on some transactions (particularly for distressed targets) than we saw in the seller-friendly M&A market of 2021 and 2022, we did not see a dramatic shift in market practice. European sellers still looked to resist more buyer-friendly U.S. styled deal terms such as bring-down of interim period covenants, the inclusion of a general material adverse change (MAC) termination right, and damages measured on an indemnity basis. However, we did start to witness more modest shifts in favour of buyers especially in bilateral situations where there is a lack of competitive tension, such as more favourable interim period covenants, the growing inclusion of deal-specific MACs and increasing requirements for sellers to repeat warranties at completion.

As we near Q2 of 2024, what signs point to a rebound through the remainder of the year?

• Q4 2023 experienced an uptick in M&A, which we are seeing continue in the first quarter of this year, possibly fueled by the expectations on both sides of the Atlantic that interest rates will fall through 2024.
• Even with a soft landing potentially coming into view, corporates and sponsors are successfully pursuing creative financing models to respond to the current high-interest rate environment and turning to private credit and bespoke equity structures to unlock financing for M&A.
• We have seen corporates increasingly working collaboratively through partnerships and joint ventures to defray costs and spread risk and we expect this trend to continue.
• Strong balance sheets for corporates, and plenty of dry powder for sponsors, means that buyers have plenty of resources to deploy for acquisitions. These resources can be deployed for strategic M&A and portfolio optimisation, each contributing to long-term business viability and growth.
• The commitments given to achieve net zero are expected to drive M&A through divestments of carbon-intensive assets and investments in renewable energy and low carbon sources such as hydrogen and carbon capture as well as technologies which are expected to contribute to the energy transition.
• Emerging technology, such as AI, also promises to drive M&A in the tech sector and beyond as companies embrace the opportunities to transform their products and services, reduce costs and diversify into new markets.

Footnotes

[1] M&A highlights 9M23: Stagnant Waters (Mergermarket data) https://community.ionanalytics.com/ma-highlights-9m23-stagnant-waters
[2] Global M&A hits the skids as Ukraine war saps confidence (Reuters) https://www.reuters.com/business/global-ma-hits-skids-ukraine-war-saps-confidence-2022-03-31/