As we move into 2024, the M&A landscape continues to evolve with notable shifts in market dynamics shaping both valuation and deal structures. These changes present important opportunities and challenges for business valuation practitioners and transaction advisors. Drawing insights from SRS Acquiom’s 2024 M&A Deal Terms Study (access the report here), which analyzed thousands of private-target M&A transactions closed between 2018 and 2023, we’ll highlight key trends and offer a look ahead to what we can expect through the end of 2024 and beyond.
Key Valuation Trends
In 2023, M&A activity saw a continuation of lower valuations, particularly in the lower middle-market deals (valuations under $50 million). According to the study, the median return on investment (ROI) for deals in 2023 was 2.5x, down from 4x in 2022. This decline is largely attributed to the increased cost of capital in 2023, as rising interest rates squeezed both buyers’ and sellers’ ability to negotiate higher valuations.
Given the interest rate environment, we anticipate that companies with strong fundamentals will retain bargaining power, but lower middle-market deals may continue to dominate the market, especially among strategic buyers.
Buyers and Deal Structure
One of the notable shifts in 2023 was the resurgence of strategic buyers, while private equity-backed buyers saw a decline in activity. This shift is likely linked to higher interest rates, making leveraged buyouts less attractive and pushing private equity firms to the sidelines.
Additionally, we observed a rise in all-cash deals in the latter half of 2023, as buyer equity became less favorable. This trend may have been driven by the rising cost of capital, incentivizing buyers to offer cash rather than dilute ownership by including equity in the transaction. As interest rates stabilize, we might see more hybrid deal structures (cash plus equity) emerging.
Purchase Price Adjustments
The “worksheet” approach for calculating purchase price adjustments (PPA) surpassed the traditional GAAP consistent with the target’s past practices for the first time, now being used in over one-third of deals. This approach helps smooth negotiations by reducing friction in determining final purchase prices, benefiting both buyers and sellers by lowering accounting and legal costs.
For valuation professionals, it’s important to understand that the adoption of this methodology might continue, as it provides a more streamlined and transparent way to handle post-closing adjustments.
Earnouts
The use of earnouts—where a portion of the purchase price is contingent on the future performance of the target company—rose dramatically in 2023. One-third of deals included an earnout, a 50% increase year-over-year, signaling stronger negotiating power on the buy-side. With the uncertain economic outlook, buyers are more inclined to include performance-based earnouts to hedge against potential downturns.
Earnouts also give sellers the opportunity to capture additional value if they are confident in their company’s future performance, making them a versatile tool for balancing risk between buyers and sellers.
Representations and Warranties Insurance (RWI)
Representations and Warranties Insurance (RWI) was identified in about 38% of deals in 2023, marking a slight decline from previous years. This could reflect a cooling of deal activity or the increased cost of obtaining such insurance in higher-risk transactions. Nevertheless, RWI remains a critical tool for protecting both buyers and sellers from post-closing liabilities and remains prevalent in many mid-market and larger transactions.
Materiality Scrapes
The use of materiality scrapes—a provision that disregards materiality qualifiers for the purposes of determining whether representations and warranties were breached—remained prevalent, with most deals including this provision for both determining breaches and calculating damages. Materiality scrapes continue to provide clarity in deals, giving buyers a better chance to recover for any inaccuracies in representations.
Looking Forward: Q4 2024 and Beyond
Heading into late 2024 and 2025, market participants expect interest rate cuts to slightly reinvigorate the M&A market. Lower financing costs will likely increase private equity activity, as the improved ROI from leveraged buyouts will attract more capital. Strategic buyers with strong balance sheets are also poised to take advantage of cheaper financing options, driving more competition and potentially increasing valuations across the board.
As private equity and strategic buyers re-enter the market with greater force, sellers may gain stronger negotiating power, which could lead to higher valuations and more competitive deal structures.
Conclusion
The M&A landscape in 2024 is characterized by lower valuations, changing buyer dynamics, and evolving deal structures. As business valuation professionals, staying attuned to these shifts—such as the rise in all-cash deals, increasing use of earnouts, and changes in purchase price adjustments—is critical for advising clients effectively. As we look toward the end of 2024 and into 2025, the anticipated easing of interest rates may re-energize the market, with more opportunities for both buyers and sellers.
What trends have you noticed in your M&A deals? Share your insights and experiences in the comments below.
