Capital Markets Update – Q3 2024

Capstone Partners Q3 2024 Capital Markets Update

Tremendous Opportunities Return to Private Businesses

It has been a painful run in the Private Business Owner Merger and Acquisition (M&A) market, especially coming off the boom market in 2021. Data to date has indicated the third year of an M&A downcycle for private businesses, which is abnormally long. However, the markets are turning, and tremendous opportunities have returned to private business owners.

Every market cycle brings unique circumstances and lessons to be learned. In this market, there are three major themes. First is that “quality” rules the roost. Marginal deals are not getting attention, due diligence is deeper, credit is tighter, and closing timelines are longer for most deals. There is a larger cohort of deals that are either getting put on hold or cancelled altogether. Specific to the private business owner, having that “special sauce” that clearly differentiates a business has been imperative. Second is a shift in appetite. Beyond being less aggressive—private equity deal volume was down 37.1% in 2023 since the 2021 peak—their focus has also been different. They generally went into hold-and-build mode, versus pursuing new platform acquisitions. From 2021 to 2023, there was a 25.2% decline in platform investments and a 34.8% decline in portfolio exits. This is off kilter from a normalized M&A market.

With the private equity community pursuing so many build strategies, private business owners must pay close attention to other private companies that are private equity-backed. Companies that maybe were not likely acquirers in the past may very well be now. Private business owners can find real opportunity in this disconnected market. There is a valuation imbalance. On the demand side, strategic acquirers are starving for growth and private equity acquirers have over a trillion of dry power capital to deploy. These factors have indicated a robust demand for M&A. However, the private business owner that is not engaging in the M&A market takes normal supply out of the market, so there are fewer deals to pursue. Good companies with strong management teams are receiving valuations at or above the highs seen in 2021. Valuation premiums exist in abundance for the right business.

Private business owners need to be smart about what’s happening in their own sector. The public headlines… the unrest in the Middle East, inflation, interest rates, recession threats, etc… do not translate to the Private M&A markets. Across many industry verticals, this supply and demand gap has created extraordinary opportunities.

Looking toward year end and 2025, there are three fundamental market demographics that will uncork this market. It’s not a matter of if, it’s a matter of when.

John FerraraFounder and President, Capstone Partners

Although total middle market M&A volume declined 9.2% year-over-year (YOY) through year to date (YTD) Q3 2024, deal activity grew 2.4% quarter-over-quarter (QoQ), marking the largest QoQ increase since Q4 2021 and the second consecutive QoQ growth in middle market transactions. While deal volumes have gained momentum moving through Q3 2024, the valuation environment has remained steady, with average deal value mirroring the past four quarters despite falling 1.5% QoQ to $68.8 million. Average EV/EBITDA multiples across the middle market amounted to 8.6x in Q3 2024, compared to 8.7x EV/EBITDA during the prior year period.

Strong average valuations in the upper middle market ($250-$500 million) during Q3 indicated a preference among buyers for businesses with a high level of scale and defensibility. The average valuation in the upper middle market improved YOY to 11.0x EV/EBITDA—leading average pricing across all enterprise value ranges. Additionally, lower middle market ($10-$100 million) valuations expanded YOY through YTD Q3 to 8.9x EV/EBITDA, outpacing the prior year period average of 8.0x EV/EBITDA. Core middle market valuations ($100-$250 million) saw valuation compression YOY with the average multiple falling more than two turns to 9.1x EV/EBITDA.

Strategic buyers continued to comprise the majority (57.2%) of M&A volume through YTD, led by private strategics (43%) horizontally consolidating peers to gain scale. Private business owners pursued capital-intensive deals, with the average enterprise value paid by privates climbing 10% YOY to $50.3 million in YTD Q3. Similarly, public companies’ average enterprise value paid grew 41.5% YOY, as management teams realign portfolios and divest underperforming assets.

Closed transactions by private equity firms registered a 7.7% decline YOY through YTD Q3. However, sponsor dealmaking in Q3 increased 8.6% YOY and 8.2% QoQ, supported by easing Debt markets and elevated dry powder. Private equity groups have increasingly focused on exiting current portfolio holdings and returning liquidity to limited partners while delaying new fundraising efforts. Although recording declines from a YOY perspective to date, private equity platform and add-on acquisitions rose 18.9% and 2.1% QoQ in Q3 2024, respectively. This marks the first back-to-back QoQ increase in platform deal volume since Q4 2021. Growing exit activity and softening Private Credit and Leveraged Loan markets have enabled the pursuit of scalable platforms. The total value of U.S. institutional leveraged loan issuance rose 123.3% YOY to $398.5 billion through YTD Q3 2024, providing an optimistic outlook for the future of acquisition appetite among financial buyers.

Capstone has identified several key themes set to characterize the M&A markets moving into 2025:

• Quality and differentiation are slated to be key acquisition criteria among strategic and financial buyers.
• Private equity capital has become increasingly impatient, providing an optimistic outlook for sponsor dealmaking in the middle market.
• Across many industry verticals, the M&A supply and demand gap has created extraordinary opportunities for middle market businesses considering a sale.
• Demographics remain a key catalyst for middle market M&A, which has created a healthy pipeline of demand as aging founders and entrepreneurs seek to monetize their business.

M&A activity outlook remains bullish as the middle market has surpassed the normal correction period, with pent-up deal demand expected to result in a pronounced recovery.

Download our full Q3 2024 Capital Markets Update Report Publication:

Request instant access to the full Capital Markets Update for a deep dive into recent Middle Market activity and trends including:

• Key considerations for middle market business owners regarding dry powder levels, buyer appetite, lending conditions, and M&A pricing trends.
• A breakdown of the top sectors preferred by Capstone’s sponsor network through YTD Q3 2024.
• An overview on Equity Capital and Credit market conditions, featuring Capstone’s Equity Capital Advisory and Debt Advisory
• Three main areas to focus on for financial reporting and accounting process improvements to ensure a successful close process, according to Capstone’s Financial Advisory Services Group.