Mergers and acquisitions (M&A) are a critical part of the global economy. They allow companies to expand their operations, enter new markets, and acquire new technologies. However, M&A activity is also heavily influenced by macroeconomic factors. In this article, we will discuss how macroeconomic indicators, such as GDP growth, unemployment rates, inflation, and interest rates, can impact M&A activity.
Relationship Between GDP Growth and M&A Trends
GDP growth is a key driver of M&A activity. A growing economy typically leads to increased corporate profits and investment, which can boost M&A deal volume. In 2021, for example, global GDP grew by 5.9%, and M&A deal value reached a record high of $5.8 trillion. However, economic growth slowed significantly in 2022, with global GDP growth estimated at just 2.9%. This slowdown in economic growth had a negative impact on M&A activity, with global M&A deal value declining by 38.8% in 2022.
The slowdown in M&A activity in 2022 was also driven by a number of other factors, including rising interest rates, inflation, and increased regulatory scrutiny. However, the slowdown in economic growth was clearly a major factor, as it led to decreased corporate profits and investment.
Impact of Unemployment Rates on M&A
Unemployment rates are another important macroeconomic indicator for M&A activity. Low unemployment rates typically indicate a strong economy with high consumer spending. This can lead to increased demand for goods and services, which can make companies more attractive to potential acquirers.
For example, in the United States, the unemployment rate fell to a record low of 3.5% in September 2022. This was the lowest unemployment rate since 1969. The low unemployment rate was a sign of a strong economy with high consumer spending. This led to increased demand for goods and services, which made US companies more attractive to potential acquirers.
However, high unemployment rates can have the opposite effect, making companies less attractive to potential acquirers. For example, in the United States, the unemployment rate rose to 14.7% in April 2020 at the height of the COVID-19 pandemic. This was the highest unemployment rate since the Great Depression. The high unemployment rate was a sign of a weak economy with low consumer spending. This made US companies less attractive to potential acquirers.
Overall, the relationship between unemployment rates and M&A activity is positively correlated. In other words, low unemployment rates typically lead to increased M&A activity, while high unemployment rates typically lead to decreased M&A activity.
Inflation and Its Effects on M&A Dynamics in the Lower Middle Market
Inflation and interest rates can also have a significant impact on M&A activity. Inflation can have a number of negative impacts on M&A activity in the lower middle market. First, inflation can make it difficult for companies to predict their future cash flows. This is because inflation can cause the prices of inputs, such as raw materials and labor, to rise. As a result, companies may be hesitant to pursue acquisitions, as they may not be sure whether they will be able to generate the necessary cash flows to service any debt that they take on to finance the acquisition.
Second, inflation can erode the value of deal consideration, such as cash and stock. This is because the purchasing power of cash and stock declines over time as inflation rises. As a result, buyers may be less willing to pay a high price for a target company, and sellers may be less willing to accept a lower price.
Third, inflation can lead to higher borrowing costs. This is because lenders typically charge higher interest rates on loans during periods of high inflation. As a result, it may become more expensive for companies to finance acquisitions, which can lead to lower deal volume. Additionally, high inflation can erode the value of future cash flows, which can also lower deal multiples.
How Inflation and Interest Rates Impacted M&A
For example, in the first half of 2023, inflation in the US reached a 40-year high of 9.1%. This led to a 37% decline in M&A deal value compared to the first half of 2022. Additionally, the average deal multiple for US technology companies fell from 14.8x EBITDA in the first half of 2022 to 12.2x EBITDA in the first half of 2023. This is a decline of over 17%.
The impact of inflation and interest rates on M&A activity is likely to vary depending on the industry and the specific company being acquired. Companies in industries that are sensitive to interest rates, such as consumer discretionary and real estate, are likely to see the biggest impact on their deal valuations. However, even companies in less rate-sensitive industries may see some impact on their deal valuations. This is because all companies will be facing higher financing costs if they need to borrow money to finance an acquisition.
Here are some other stats on the impact of inflation and interest rates on M&A activity:
- A recent survey by KPMG found that 73% of global M&A executives believe that rising interest rates will have a negative impact on M&A deal volume in the next 12 months.
- A report by investment bank Jefferies found that the average time it takes for an M&A deal to close has increased from 6 months in 2021 to 7.5 months in 2023. This is due in part to increased regulatory scrutiny and higher financing costs.
- A survey by law firm Baker McKenzie found that 62% of M&A lawyers believe that private equity firms will be the most active buyers in the M&A market in 2023. This is because private equity firms have access to large pools of equity capital and can be flexible on how they structure transactions often allowing them to be less reliant on debt financing.
Consumer confidence is a measure of how confident consumers are about the future of the economy. Consumer confidence is important for M&A activity in the lower middle market because it is a driver of economic growth. When consumers are confident, they are more likely to spend money on goods and services. This increased spending can lead to increased sales and profits for companies, which can make them more attractive to potential acquirers.
Conversely, when consumers have low confidence, they are less likely to spend money on goods and services. This decreased spending can lead to lower sales and profits for companies, which can make them less attractive to potential acquirers.
Overall, consumer confidence is a key driver of M&A activity in the lower middle market and is positively correlated. When consumer confidence is high, M&A activity is likely to be strong. Conversely, when consumer confidence is low, M&A activity is likely to be weak.
Manufacturing output is a measure of the amount of goods being produced in an economy. Manufacturing output is important for M&A activity in the lower middle market because it is a measure of the strength of the economy. When manufacturing output is high, it indicates that the economy is strong and growing. This can make companies more attractive to potential acquirers, as acquirers are more likely to be interested in acquiring companies that are operating in a strong economy.
Conversely, when manufacturing output is low, it indicates that the economy is weak and shrinking. This can make companies less attractive to potential acquirers, as acquirers are less likely to be interested in acquiring companies that are operating in a weak economy.
Overall, manufacturing output is a key indicator of the strength of the economy, and therefore M&A activity. When manufacturing output is high, M&A activity is likely to be strong. Conversely, when manufacturing output is low, M&A activity is likely to be weak.
The Broader Picture: Economic Cycles and M&A
M&A activity is also influenced by the broader economic cycle. During periods of economic expansion, M&A activity tends to be high, as companies are more likely to invest in growth and expansion. For example, in the US, M&A deal value reached a record high of $5.9 trillion in 2021, during the post-pandemic economic recovery. However, during periods of economic contraction, M&A activity tends to be low, as companies are more focused on conserving cash and weathering the storm. For example, in the US, M&A deal value fell to $3.6 trillion in 2022, as the economy began to slow down.
According to a recent survey by KPMG, 62% of global M&A executives believe that the current economic environment is “more challenging” than it was a year ago. This is due to a number of factors, including rising interest rates, inflation, and the ongoing war in Ukraine.
Despite the challenging economic environment, there are still some factors that could support M&A activity in the near term. For example, private equity firms are expected to remain active buyers, as they have access to large pools of capital. As of July 2023, global private equity dry powder is estimated to be around $3.7 trillion (Bain & Company). This is a record high, and it is a sign that private equity firms are eager to invest in new companies. Additionally, companies in certain sectors, such as technology and healthcare, may continue to pursue acquisitions to expand their product offerings and enter new markets.
Overall, the outlook for M&A activity in the near term is mixed. The challenging economic environment is likely to dampen deal volume and valuations. However, there are still some factors that could support M&A activity, such as the strong demand for deals from private equity firms and companies in certain sectors.
Geopolitical Risk and M&A Uncertainty
Beyond the vagaries of economic cycles, the specter of geopolitical risk looms large in shaping M&A activity. Tensions between countries, trade wars, and even open conflict can make boardrooms skittish. Regulatory landscapes can shift overnight, and tariffs can suddenly make an acquisition less appealing or even untenable. Political uncertainties, such as elections or abrupt policy shifts, add another layer of complexity. Investors eyeing cross-border deals are particularly vulnerable. In this volatile climate, due diligence needs a wider lens, extending from market fundamentals to the corridors of power in relevant jurisdictions.
The unpredictable nature of geopolitics can offer both hazard and opportunity. Some firms find underpriced assets in politically unstable regions—high-risk gambles with potentially high rewards. Conversely, companies perceived as national champions could find themselves off-limits to foreign acquirers, an invisible hand tipping the scales of market dynamics. Therefore, an adept reading of geopolitical risk is not just prudent but can be a strategic asset in itself, providing a competitive edge in M&A decisions.
Astria LLC: Guiding Your M&A Journey Amid Macroeconomic Shifts
Macroeconomic indicators can have a significant impact on M&A activity. Companies that are considering M&A transactions should carefully monitor these indicators and assess how they could impact their deals.
Navigating the M&A landscape amid fluctuating economic indicators alone can be daunting, especially for sellers in the lower middle market who may have never sold a business before. Astria LLC provides tailored strategies to demystify this complexity. Let us help you capitalize on favorable macroeconomic trends and secure an optimal exit. Reach out for a consultation that could very well redefine your financial future!