Mid-Year M&A Dealmaking and Disputes Update

Reflecting on the past six months of M&A—and looking ahead to the next six

Last fall, BRG released its 2021 M&A Disputes Report. In the midst of record-high deal volume, the survey unpacked the growing number of M&A disputes—spurred by new deal structures, new investment vehicles, advances in technology, and changing economic conditions.

With the first half of 2022 behind us, we checked in on where things stand. We connected with BRG Managing Director Dan Galante, who has more than twenty-five years of transaction experience advising companies around the world. In what follows, we discuss the state of current M&A activity and disputes, the impact of present economic headwinds, the dealmaking outlook for the rest of 2022, and more.

Heavy M&A activity was taking place when we put together last year’s M&A disputes report, and that continued through the rest of 2021. Have you seen any signs that things are slowing down or might slow down soon?

M&A activity set all sorts of records in 2021. I focus on the middle market, and that segment had the most activity I’ve seen in the past twenty-five years. Activity remained strong in January after the holidays; there was a little dip in February, and then things came roaring back in March. Despite current economic headwinds, I still expect mid-market M&A activity to remain strong throughout the rest of 2022.

There are a few reasons for that. From a private equity standpoint, there’s a lot of dry powder in terms of equity capital. Commercial banks also have a lot of capital they can put into transactions—and they’re being aggressive about increasing leverage multiples. Simultaneously, interest rates continue to be relatively low compared with historic norms, and corporations have a lot of cash on hand. They can either send it back to shareholders or reinvest.

Put it all together, and you have an appetite for deals, plenty of capital, and not enough companies for the demand that’s out there.

Experts we interviewed for the report last year said the increase in disputes wasn’t simply about more deals happening. They pointed to other factors, specifically changing trading patterns, volatile pricing, and quick transactions. Have those factors continued? And is there any sign they’ll fade away or normalize?

Transactions continue to become more complex, and it is difficult to clearly document the intent of each party. With high valuations and higher activity, I would expect increases in the number of disputes and the stakes to be higher in the future.

Higher valuations mean there’s less room for error and increase the possibility of disputes. Some mechanisms—like reps and warranties insurance—have emerged in recent years to mitigate the number of disputes. But the sophistication of the target companies, the increasingly complex nature of the analysis that goes into understanding the companies in the due diligence process, and the level of leverage and prices being paid mean disputes will remain high, especially with the high deal volume.

Have you had one transaction that you think sums up the recent dealmaking environment?

So much of what we’re seeing comes back to the overall supply-and-demand imbalance, which increases the need for sell-side quality of earnings information to better communicate present and—importantly—future financial performance. I worked with a company from the sell side that had $50 million of negative working capital, which meant we had to provide support that showed the negative working capital was sustainable—that it would become a cash-generating businesses. We knew that as the company grew, it would generate more cash through its supplier credit terms, but that’s difficult for investors to understand.

We’ve seen this a lot in the value-added distribution industry, which provides products in bulk for technology companies (along with services like market and product expertise and white-label tech support). Buyers of these businesses sometimes struggle to get comfortable with the idea that their terms with technology companies may be longer than their customers’ terms and sustainable.

Seventy-five percent of respondents to 2021’s survey expected at least a slight increase in deal volume, and thirty-five percent expected an increase of twenty percent or more. With the benefit of hindsight, were those sentiments overly bullish, overly bearish, or about right?

They were right for 2021: we saw an increase, and in certain segments that increase was certainly more than twenty percent. That said, there were pockets where things weren’t as strong: energy is starting to come back after being low in things like oilfields. But technology, consumer, industrials, and particularly healthcare all saw strong activity. Healthcare is probably thirty percent of middle-market M&A activity right now, with a lot of rollups of physician practices and large consolidators that are acquiring larger businesses. That sector should continue to be extremely strong going forward.

If we asked businesspeople involved in M&A today about the outlook for the next twelve months, what would we hear?

It is tough to predict the percentage increase, and a lot depends on the segment and size of transactions. But I expect continued robust M&A activity into 2023. As for the overall economy, which of course affects M&A, we’ll see some impact of recent interest rate increases throughout this year. The Fed so far has been aggressive to curb inflation and keep us out of a recession, which makes sense. Meanwhile, corporate profits are at such high levels, and companies that were strategic and aggressive about pricing through the supply chain imbalances should continue to do quite well.

What effect do you expect the easing impact of the pandemic to have on deal activity? Have dealmakers’ approaches or mentalities changed after the pandemic difficulties of the past two years? Are they used to operating amid more uncertainty?

The business and financial impacts of the pandemic on deal activity are largely over. The adjustment period probably lasted until the end of 2021, but now there’s an understanding of the pandemic impact and how buyers have changed their approach to target companies. In fact, many companies used the pandemic to reevaluate how they do things and reduce costs.

Even the industries with the biggest pandemic hangovers—like restaurants and retail—look strong now compared with 2019. We’re seeing growth greater than inflation in most industries, and corporate leaders really have moved past thinking about the pandemic impact. The government support since the pandemic began might have been too generous, and we’ll certainly pay for it down the line when it comes to the national debt. But it did help get most companies out of trouble sooner than we might have expected two years ago.

The dealmaking environment is changing fast. In our next update, we’ll talk with BRG Managing Director Mustafa Hadi about the influence that geopolitical turmoil and economic headwinds may have on M&A and deal-related disputes in the second half of the year, ahead of BRG’s forthcoming 2022 M&A Disputes Report.