That was the year that wasn't: M&A takeaways from 2023

For many parts of the M&A market, 2023 will be a year best forgotten.

According to analysis by Pitchbook, 2023 is on course to clock the lowest M&A deal value since 2013.

The US$776.8 billion of recorded deal value from July to September 2023 was the lowest quarterly total in nearly 10 years outside the COVID-19 lockdown of Q2 2020, and 49% below the all-time quarterly peak of Q4 2021.

While deal value is down significantly on 2022, at the end of Q3, year-to-date deal count was only 2.5% lower over the same period last year, indicating that fewer 'mega-deals' are characterising the market.

At Fieldfisher, despite this backdrop our M&A practice remained active, particularly in certain sectors such as AI (although this remains nascent), business analytics, open banking, travel, business services, ESG and renewables.

Distressed sales and restructurings have unsurprisingly been a noticeable feature of the M&A market this year.

A challenging fundraising environment has led to earlier exits at lower prices than might have been previously expected and dual track fundraises and M&A processes are on the rise.

Carve outs have also been more popular, as buyers are being selective about what they want to pay for, and sellers do not want to give up discrete parts of their businesses with clear potential. 

Due to reduced lending in the market, those with strong balance sheets have been picking up good deals, and a number of our international M&A clients look to be on course for a record year.

Strategic investors and buyers have been filling the void left by private equity, although many are holding back until the market regains some balance, when strategic imperatives for making acquisitions are more obvious.

Below we summarise some of the key trends we have seen in M&A in 2023.

• Longer timelines

Deals took significantly longer to close in 2023 than they did in 2022.

Most have been 'stop-start' in nature, and while many deals commenced on an 'urgent' basis, the majority have taken longer to conclude than we would expect in a less stressed market.

A contributing factor to these extended timescales was the tendency to negotiate hard over relatively minor aspects of deals, which in 2022 would not have been such deeply contentious points.

• Contingency over consideration

Sellers have been coming under more pressure to accept contingency payments and earn outs, by agreeing to share in future upside of the business post-sale, and in some cases deferred payments without contingent consideration, rather than taking payment in full upfront.

While these payment structures can have benefits for both sides, they are effectively attempts to skew the purchase price to a point in the future.

Consequently, they tend to provoke stiff and lengthy negotiations about how this future upside will be captured, adding time, cost and risk to the deal process.

• Restructuring earn outs

While disputes over contingent earn outs are relatively rare, 2023 saw a clear trend towards restructuring earn outs.

Contingent earn outs can lead to tax inefficiency, because they effectively transform equity-based forms of payment into something that looks more like a bonus.

These payments have to be put through the company payroll, and income is taxed more heavily than capital.

An additional complication is that contingent earn outs are often predicated on a certain number of employees still being in employment at the at that point the payment falls due, but a tight labour market has made retention challenging, particularly in the fast-moving tech space.

• Less headroom for PE lenders

Private equity buyers who typically account for a sizeable chunk of the M&A market for late-stage businesses found that their traditional lenders were closer to the top of their headroom for debt financing in 2023 than they were a year ago.

This has affected the leveraged buy-out market, with the consequence that private equity transactions are either smaller, or the equity side is having to make up more of the total purchase price, rather than relying on debt.

Private equity buyers are also very sensitive to macro-economic conditions and wider economic confidence, resulting in a retraction of capital this year.

This has been particularly evident in the context of platform deals (where private equity buyers enter new markets via acquisitions), as opposed to bolt-on deals (in sectors where the private equity buyer already has a position).

• Break fees gain prominence

With deal execution risk at the highest level it has been for some years, discussions around break fees have been far more significant elements of deal negotiations.

With both buyers and sellers worried about deals collapsing, they are focusing on who will cover the costs of transactions falling through – to the extent that some buyers are insisting that sellers pay their fees.

• Regulatory friction

Against a more challenging global geopolitical backdrop, in the UK, the National Security and Investment Act (NSIA) is playing an increasingly important role in M&A, particularly in deals involving international buyers.

While very few deals have so far been blocked under the NSIA, the obligation to notify now applies to a significant proportion of UK M&A deals.

This slows transactions down and adds to the cost, while risk perception is sufficiently high to push clients to seek comfort that deals will proceed.

While the UK is not the only country to have introduced new/updated foreign direct investment legislation, because the NSIA is still relatively new and the regulator seems to be struggling to cope with the volume of notifications, it is adding friction to UK M&A deals.

In the last 12 months, we have advised on a substantial number of deals that have required a mandatory notification, or we believed it prudent to make a mandatory notification (and sometimes had to persuade the Investment Security Unit (ISU) that it should be mandatory, because we needed certainty), or a voluntary notification was appropriate.

It was also occasionally necessary to persuade the ISU that notification was unnecessary, after it raised questions about deals it considered should have been notified.

• Speciality Finance

The void left by traditional lenders has proved challenging for private equity funds this year but this has created an opportunity for speciality lenders.

According to a white paper published by KKR in May (Asset-Based Finance: A Fast-Growing Frontier in Private Credit) the private asset-based finance asset class has grown substantially over the last couple of years and is set for further growth next year.

This market requires a range of specialist banking skills focused on consumer loans, with security taken over working capital, equipment, supply chains and other physical assets.

However, for funds that are nimble and don't leave the debt component to an afterthought (i.e. bring in debt providers as soon as they start looking at a target), this may help dealmakers get ahead of the queue.

Looking ahead to 2024

Countries with elections in 2024

The M&A market requires stability to accelerate deal activity.

In Q4 2023, there have been early signs that interest rates may be stabilising and inflation is coming down.

However, there remains a great deal of political uncertainty, with 2024 set to be the biggest global election year in history (by number of people voting), and destabilising conflicts in Ukraine and the Middle East continuing to affect markets more broadly.

For more information on how we are helping M&A clients to steer through the challenging transaction environment, please contact us.