As we write this quarter’s newsletter in mid-December 2024, we are excited about what the new year may bring! RSM’s transaction professionals are tracking a slow and steady increase in M&A activity and sensing renewed optimism from our private equity clients and investment banking contacts.

This shift was influenced by several factors: the clarity following the presidential election, anticipated reductions in Federal Reserve interest rates, macroeconomic tailwinds and expectations of a more business-friendly regulatory environment.

Key M&A activity to watch

• Market sentiment: Optimism is growing as firms expect a rebound in deal-making.
• Interest rates: M&A lending rates will drop as the Federal Reserve continues lowering interest rates. As rates tick downward, the bid/ask spread between buyers and sellers will narrow, easing enterprise value discrepancies and bolstering deal financing.
• Continuation vehicles: Continuation vehicles, which regained popularity in 2024, will likely remain a vital liquidity tool. These vehicles provide flexibility for private equity sponsors holding assets longer than usual and for portfolio companies not yet ready to transact.
• Longer hold periods: PE firms face elongated holding periods for portfolio company assets but expect a surge in sales as these investments eventually hit the market.
• Regulatory environment: While heightened regulatory scrutiny and antitrust pressures present challenges, they also create opportunities for private equity firms to step in where corporate strategic buyers may hesitate. However, if the regulatory environment becomes more business and M&A-friendly, it may produce another catalyst for increased deal activity, including more competition between PE and corporate acquirers.
• IPO resurgence: Exit activity is another dam that is expected to break. We have heard from many private companies analyzing the potential for an initial public offering (IPO) exit in the coming quarters. This includes larger PE-owned assets that may utilize the public markets as an exit avenue in 2025.
• Private credit: We have seen a significant uptick in private credit fundraising in recent periods and expect this activity to continue, regardless of where interest rates land.
• Platform acquisitions: Middle market deals have increasingly focused on add-ons and tuck-ins, but platform acquisitions are also expected to grow. These platform acquisitions will enhance deal volumes, reinforcing positive market sentiment.
• Tax policy: The market will be closely watching the new administration’s tax policies, and business-friendly changes could favor profitability (and cash flow), incentivizing domestic investment.

The outlook

2025 presents a dynamic landscape for private equity and M&A. With optimism spurred by improving economic conditions and evolving market dynamics, the stage is set for a potential surge in activity. Challenges remain—such as regulatory scrutiny and market volatility—but opportunities abound for firms ready to adapt. As these trends unfold, 2025 could mark a pivotal year of growth and transformation for the M&A market.

In today’s private equity (PE) landscape, trends in dealmaking are evolving rapidly in response to economic pressures. As a firm deeply immersed in this space, RSM is seeing a heightened emphasis on profitability and a growing reliance on granular data to substantiate profitable growth assertions in mergers and acquisitions (M&A) and refinancing events. These trends are shaping the strategies of PE investors, lenders and portfolio companies.

Profitability and margin focus

Investors are diving deeper into data to validate claims of operational improvements. No longer satisfied with high-level diligence, they demand a full revenue and gross margin bridge, examining everything from price impacts to cost-per-unit impacts, volume changes, and sourcing and labor efficiencies. For example, in consumer products or industrials companies, PE firms are going down to the stock keeping unit (SKU) level to ensure real margin improvement, not just growth in sales, accounting pricing variability and SKU customization for different customers.

This diligence extends to proving that any price increases won't result in a decline in volume or market share. Investors look closely at backlogs, pipelines and customer behaviors to assess what sustainable price changes might be. Before, when capital was more readily available, firms were willing to accept high-level anecdotal stories. Now, in this constrained market, everyone wants the most granular data available to validate a portfolio company's equity story.

Refinancing and debt management

Another significant trend we're seeing is a rise in refinancing activities. Many portfolio companies, especially those that have grown through acquisitions, are now facing debt maturities from loans secured in 2020 or 2021. With market conditions tightening, PE firms and portfolio companies are preparing to refinance these debts.

Additionally, dividend recapitalizations are popping up as a means for PE firms to extract value from their investments. These transactions allow financial sponsors to generate liquidity while maintaining their ownership stakes. In today’s environment, where profitability is prioritized, these recapitalizations often focus on ensuring that any distributions don’t jeopardize the company’s operational or financial stability.

Deeper reliance on data

Data has become a cornerstone of modern PE dealmaking, particularly in the current economic climate. Gone are the days when investors were content with broad overviews and anecdotal stories about a company's growth potential. Now, data-driven diligence is paramount. Investors want access to transactional-level data as early as possible to validate claims of growth, profitability and operational improvements. Whether it’s assessing the success of a product launch or the validity of management’s claims, PE firms now demand concrete data to back up the narrative.

Moreover, data is no longer something requested toward the end of the deal process. It’s now a critical component from the very start, often forming the foundation upon which investment decisions are made. This level of diligence, which once might have been seen as overkill, is now table stakes in PE dealmaking.

The outlook

Expect these trends to continue shaping the PE landscape into 2025. The focus on profitability and margin sustainability will likely intensify, particularly in sectors where inflationary pressures and rising input costs pose significant challenges. Refinancing will remain a key theme as companies look to manage their debt loads in a more constrained lending environment.

Data will only become more central to the deal process, with investors requiring more granular and earlier access to validate the investment thesis. In an era where anecdotal evidence no longer suffices, data-backed insights will separate the winners from the losers in PE dealmaking.

For investors, staying on top of these trends is crucial. It’s not just about identifying the next big growth story; it’s about ensuring that the story is backed by solid fundamentals, sustainable margins and real operational improvements. As the environment grows more challenging, the ability to drill down into the details will be what sets successful investors apart from the rest.

We would love to hear your questions, concerns and comments on the role of granular data in deal analytics and due diligence. Please reach out and let us know your thoughts.

In this quarter’s newsletter: A midyear check-in on our 2024 forecast and an updated outlook for the remainder of the year. 

How did our predictions hold up?

As we entered 2024, we observed that merger and acquisition (M&A) deal activity was returning to its normal growth trend and made several predictions about where the market was likely headed. Now that we are halfway through the year let’s see if our predictions are still on track. 

Ahead of 2024

What we said: Three major themes surfaced in RSM’s 2024 Private Equity Outlook. Namely, carve-out transactions would remain strong, roll-up strategies would keep on rolling, and technology and health care deal volume would rebound.

What occurred:

• Carve-outs: According to PitchBook’s Q1 2024 US PE Breakdown report, for the past four years, carve-outs as a percentage of total PE buyouts have ranged between 5% and 11%. In Q1 2024, this share increased to 12.6%. RSM has seen an increase in carve-out engagements so far this year, although many of these deals have yet to close.
• Roll ups: PitchBook also reported that PE add-on transactions ranged from 60% to 69% of total PE buyout deal volume from 2014 through 2020 but skyrocketed to the 75% range in the past couple of years. This share remained consistent in the first half of 2024, at approximately 75%. As a testament to this trend, approximately 65% of RSM’s deal volume is PE add-ons.
  
• Technology and health care: As we reported in our outlook, technology deals have increased in 2024 when compared to 2023, albeit not at the pace we were estimating. We believe this is primarily due to the Fed’s delay in interest rate cuts. Health care deals seem to have stagnated due to higher interest rates and the complex regulatory environment.

January 2024

What we said: There will be a surge in corporate energy-sector deals.

What occurred: So far this year, energy-sector transactions are tracking with 2023 deal counts, reads PitchBook. Two major deals in the corporate (non-PE) space completed in recent months are ExxonMobil’s $60 billion acquisition of Pioneer Natural Resources, and Sunoco LP’s $7.3 billion acquisition of NuStar Energy L.P. Renewable energy appears to be the new M&A darling, as we continue to see an overall increase in deal activity for the sector.

April 2024

What we said: An expected drop in interest rates will lead to more PE-backed portfolio company sales. Also, we expected to see a surge in continuation funds due to longer investment hold periods.

What occurred: While RSM’s transaction advisory practice has experienced an uptick in sell-side inquiries, it is not at the expected volume. We believe macroeconomic headwinds and higher interest rates have deterred many middle market fund managers from initiating the sell-side readiness process.

A recent article in Private Equity International discussed the wall of assets that need to change hands and how sellers face an exit plan dilemma amid an emerging buyer’s market. Indeed, current market conditions have led managers to consider new liquidity solutions and exit offramps, such as continuation vehicles, as more funds approach the end of their lives.

Continuation fund-related exit count increased substantially in Q1 2024 and is on pace to reach about 100 exits in 2024, more than any other year in the recent past, according to PitchBook’s 2024 US Private Equity Outlook.

While this surge of continuation funds is expected to continue, it is not a long-term solution for the industry. In this higher-for-longer interest rate environment, buyers and sellers are getting used to the fact that the PE market is shifting. As valuations are right-sized, M&A activity will normalize with a renewed focus on dealmaking.

The outlook

After appearing to bottom out in 2023, the overall M&A marketplace is on the upswing; however, an increase in deal activity depends on whether interest rates get cut and if the industry can steer clear of major headwinds. Ironically, these two factors are inversely related: The more headwinds the market faces—such as an economic slowdown that leads to job losses and a drop in consumer purchasing power—the more likely the Fed will start cutting rates.

While the timing of rate cuts remains uncertain, we are cautiously optimistic about the M&A forecast, barring any drastic changes in the macroeconomic and geopolitical landscape. Even with the upcoming election season, we don’t expect any material changes to market activity, regardless of who wins.

RSM’s transaction advisory services practice continues to grow, our pipeline is strong, and we remain committed to helping clients navigate the opportunities and challenges ahead. We would love to hear your questions, concerns and predictions for the M&A market in the coming months. Please reach out and let us know your thoughts.

In this quarter’s newsletter: Key considerations ahead of increased merger and acquisition (M&A) activity, the rise of continuation funds, plus access to insights to help you get ahead of opportunity.

Two years of pent-up supply

As we forecasted back in December 2023 and in RSM’s 2024 Private Equity Outlook, deal activity is on track to return to its normal growth trend. We are cautiously optimistic about the second half of 2024 when an expected drop in interest rates may help to spur M&A transactions, in addition to the overall macroeconomic environment. The question is, will pent-up demand incite a wave of portfolio company sales?

Just the possibility of that happening should get fund managers thinking about how to prepare for the opportunities to come. From the RSM perspective, sell-side readiness helps accelerate the marketing process and shrink timelines for more efficient dealmaking. Considerations should include not only performing a quality of earnings analysis (now a common practice) but also assessing all functional areas of the business and aligning the portfolio company management team with your strategy.

Sell-side readiness facilitates a more efficient transaction and offers a better understanding of a company's strengths and weaknesses. Getting ahead of the game 12 to 18 months in advance of taking a company to market will facilitate working with key stakeholders and instill confidence in potential buyers.

Here are potential workstreams that a PE-backed portfolio company could perform as part of preparing for sale. Keep in mind this is not meant to be an all-encompassing list.

Commercial assessment of the business: Can you clearly articulate where and how the business operates and what upside exists for the future buyer?

Back-office functional area assessment: Accounting, finance, IT, operations, human resources, etc.—where are there areas for improvement, and are there any “quick wins” that can be accomplished prior to the sales process?

Data strategy: Buyers request a ton of data; are you ready for this? Consider a practice session and/or going through a sell-side diligence “Phase I” type of process to understand how fast you can produce data and the accuracy of the data supporting the historical financial statements.

Management preparation: Who from management will be answering questions from buyers? Are they ready to answer the voluminous questions that will be asked? Consider a practice session for this, especially around finance and accounting matters.

Longer holding periods but no time to waste

Investment hold periods increased during the lull in M&A deal activity over the past two years. Buyers sought to drive prices down or hold off making offers, while sellers were reluctant to sell in anticipation of better market conditions. The result of all this watching and waiting is an excess supply of portfolio companies. One interesting trend that has occurred due to these longer hold periods is the increased usage of continuation funds. A continuation fund in private equity is a strategy allowing fund managers to hold onto investments longer than the original fund's term. Typically, this involves setting up a new fund vehicle (the continuation fund) by the same sponsor to acquire one or more assets from an existing fund. This allows sponsors to continue managing strong assets beyond their original fund's life cycle, potentially maximizing value creation.

Investors from the existing fund are often given the choice to either exit by selling their interests or to roll over their interests into the new continuation fund, which may also involve committing additional capital. For the investors, this provides an option for liquidity or continued investment, which can be particularly attractive in volatile markets or when the assets have not yet reached their full exit potential.

The popularity of these strategic vehicles has been growing, as they offer liquidity for existing investors or the ability to remain invested in high-performing assets. By extending the timeline of an asset, stakeholders aim to increase the potential upside of its eventual sale. Continuation funds also buy time for managers to realize their investment thesis by making operational improvements to maximize value creation.

While the current fundraising environment is challenging, we’ve heard from middle market private equity firms that they expect to exceed their hard cap based on prior deals surpassing expectations, which has resulted in new and existing LPs clamoring for a spot in the new fundraise.

What are your thoughts on the current private equity market? Please feel free to reach out to us to discuss.

In this quarter’s newsletter: Energizing merger and acquisition (M&A) activity, key factors driving trends, plus access to insights to get you off and running in the new year.

An uptick in M&A activity with an interesting twist

As we write this quarter’s newsletter in mid-December 2023, we do not have the final tally of M&A deal volume for the calendar year, but we can say there has been an uptick in activity during the fourth quarter. While we don’t expect to achieve the record-breaking deal volumes of 2021 and 2022, the result of a pandemic-induced frenzy of M&A activity, 2023 was not a sleepy year from a historical perspective.

Last quarter, we discussed how muted private equity platform deals were due to the higher interest rate environment, bid-ask deltas between buyers and sellers, geopolitical unrest and other macroeconomic headwinds. However, smaller add-on transactions remain prevalent as private equity firms continue to bolster portfolio company growth through acquisitions in a slower-growth environment.

We are tracking a growing trend in the resurgence of the corporate or “strategic” acquirer, aka a nonfinancial sponsor, likely due to several reasons. Corporate acquirers are less affected by a rising interest rate environment, as they often fund an acquisition with their existing balance sheet. Corporate acquirers tend to have different rationales for purchases, such as adding new products or services, expanding geographically, increasing production to reduce the overall cost of goods sold, etc. A synergy benefit to a corporate acquisition is typically inherent in the overall deal thesis.

A surge in corporate energy-sector deals

One area in which our corporate M&A practice is experiencing significant growth is in corporate energy, according to Ryan Bosworth, RSM partner and transaction advisory services corporate channel leader. Our growing list of clients comprises public and private entities with annual revenues ranging from $500 million to over $20 billion. Bosworth notes that corporate acquirers often focus on middle market M&A to drive strategic transformation and accelerate growth.

Adding insight is Scott Barcroft, RSM partner and transaction advisory services value creation leader, who says a key component of most corporate deals is the ability to create and realize synergies and operational efficiencies. Larger corporate buyers typically have robust infrastructures that allow for significant rationalization of back offices, enhanced purchasing power and operational know-how, all of which can positively impact deal economics. Corporate buyers, particularly public entities, are much more likely to invest significant time and effort to realize synergies to their maximum potential. RSM’s recent discussions with corporate chief financial officers (CFOs) indicate more robust deal activity as we head into 2024, especially among well-capitalized entities needing to drive shareholder value.

A confluence of factors has driven the surge in corporate energy-sector deal activity. With a growing emphasis on sustainable practices and renewable energy sources, traditional energy companies strategically leverage M&A opportunities to position themselves in the evolving market. Notably, major players are eyeing partnerships and acquisitions in the renewable energy and carbon recapture sectors to capitalize on the global shift toward cleaner energy solutions.

The technological frontier is another key driver of corporate energy M&A trends. Innovations in energy storage, smart grids and digital solutions are prompting companies to engage in strategic acquisitions or investments to stay ahead of the curve. As the industry embraces digital transformation, M&A deals are about securing physical, cash-flowing assets and acquiring technological capabilities that enhance operational efficiency and reliability.

M&A outlook: What’s in store for 2024

RSM’s M&A practice has observed this rapid push to invest in renewables from both existing and new clients and also increased deal activity in conventional energy sectors, such as oil and gas exploration, oil field services and fossil-fueled power generation. Looking ahead, we expect the corporate energy M&A landscape to remain dynamic, with a continued focus on sustainability, regulatory shifts and technological advancements shaping the trajectory of transactions and future investment. 

Here's how we see big corporate activity in the energy arena taking shape:

• Many corporate roll-ups/strategies gobble up smaller assets/competitors.
• Lenders are less likely to cash flow lend in the space, which means corporate acquisitions will depend on an incredibly strong balance sheet.
• Collateralization for lending is equipment-driven, further complicating acquisitions for smaller investors due to capex requirements.

One factor that could slow corporate M&A activity is the changing regulatory environment. We expect the upcoming election cycle and continued unrest in global commodity markets to alter regulations further and influence the overall economic landscape.

In this quarter’s newsletter: Smaller deals making a big impact, the merits of back-office automation, plus access to insights to keep you well prepared to succeed.

Smaller deals making a big impact

Three quarters into the year and we are seeing more of the same. Well, sort of. While it has been a difficult period for middle market mergers and acquisitions (M&A) deal-making, we are tracking some interesting developments unfolding in the marketplace.

Deal activity in the first half of 2023 mostly mirrored the second half of 2022, primarily due to macroeconomic headwinds, the Federal Reserve’s interest rate environment, and inflation wreaking havoc on middle market businesses and investors.

A growing discrepancy between buyers and sellers over enterprise value expectations has, in many instances, elongated deal processes or broken them altogether. Industry sources report that multiples (enterprise value/EBITDA) are down from prior years for the first time in a long time. This valuation reset could be good for the overall marketplace, but it will likely take a while to normalize fully.

For private equity buyouts, platform acquisitions remain at the lowest levels during the past decade; however, higher add-on transactions have partially offset this lull. Smaller deals are easier to complete and have become prevalent in the industry as part of a “roll-up” strategy, whereby multiple companies are acquired to form a much larger entity, thus consolidating the market.

RSM transaction advisory services hit a peak in July for the year, which could be a reason to get excited about the fourth quarter and heading into 2024. Meanwhile, our sell-side due diligence deal volume as a percentage of the total was higher than normal during the second and third quarters, which may indicate a busy post-Labor Day fall season.

The merits of back-office automation

Economic pressures and a potential recession have pushed many private equity portfolio companies into preservation mode. Chief financial officers (CFOs) are shifting their focus from high-stakes digital transformation to low-code automation of the back office.

For much less investment and little coding knowledge, you can streamline many back-office processes that involve tedious, repetitive, manual tasks across complex systems and applications to drive scalability. Let me share an example of how process automation helped one of our clients overcome its growing pains following a series of mergers and acquisitions.

RSM client benefits from process integration

After growing from eight properties to over 1,500, a global hospitality company’s business processes became highly disjointed among legacy groups, resulting in duplicative work and inconsistent service quality. Moreover, many of these processes were highly manual and time-consuming, leaving little opportunity for the staff to focus on strategic initiatives.

After a private equity firm acquired a majority stake in the company, the push to integrate processes across the organization accelerated. Leadership zeroed in on robotic process automation (RPA) as a first step in gaining efficiencies and engaged RSM to assist with selection and implementation.

RSM led an independent review of the company’s people, processes and technology to identify integration opportunities within existing applications. We leveraged “fit-for-purpose” technologies combined with RPA to optimize business processes and data flows.

By expanding platform usage to eliminate repetitive manual tasks, the company significantly improved its process efficiency, including a 65% reduction in manual account reconciliations. Productivity also increased, and by saving more than 350 full-time equivalent (FTE) hours per month, the company’s workforce was able to redirect their efforts toward core business functions and drive value.

Business-led technology enablement has become imperative for middle market companies to succeed in these challenging times. As a leading provider of systems and solutions, RSM has the experience, industry knowledge and resources to help you drive value from the back office.

In this quarter’s newsletter: Staying focused on optimization and rationalization and why your existing portfolio matters more now than ever.

Our view of the current middle market M&A landscape

The outlook remains uncertain for private equity mergers and acquisitions, with deal count faltering by another 9.3% from the fourth quarter of 2022, according to PitchBook’s latest U.S. PE Breakdown.

There’s also a new dynamic happening between buyers and sellers regarding the bid-ask spread for transactions. The average multiple for middle market PE deals is shrinking, so price negotiations are taking longer.

We are still seeing deals get done but not as much upmarket activity or billion-dollar-plus transactions. There’s a heavier concentration in the lower market, with fewer platform acquisitions and more add-ons to existing portfolio companies, primarily because they are easier to finance and execute than larger buyouts.

Another trend we’ve noticed is the uptick in sales preparation by PE firms amid speculation that the M&A market may turn as early as the second half of 2023 or the first quarter of 2024. Firms are planning ahead to ensure they will be transaction-ready for when the time does come.

The existing portfolio matters more now than ever

Many of our PE clients are concentrating their efforts on existing portfolio company operations, focusing on optimization and cost preservation to build exit value and using cash flow modeling to understand the impact of rising interest rates. Firms with high-performing portfolio companies are also assessing their exit strategies to consider all available options.

RSM now forecasts a 75% chance of a recession over the next 12 months due to tighter lending standards following the recent turmoil in the banking sector. Meanwhile, portfolio companies already have to deal with stubborn inflation, global uncertainty, supply chain issues and a talent shortage, all contributing to an increase in cost structures.

In response to these challenges, private equity firms and their portfolio company management teams are looking inward with an eye on cost optimization and operational improvement. By analyzing their selling, general and administrative expenses and improving operational efficiencies, private equity-backed portfolio companies (portcos) can reduce 10%-25% of their selling, general and administrative (SG &A) expenditures, increase operational efficiencies and increase EBITDA. 

Now that deal flow has slowed, firms are also evaluating their portfolio operating models and investing in people, process and technology while time permits. As always, the goal should be to do more with less. If automation can be enhanced by just 20%, it essentially eliminates the need for strategic outsourcing by eliminating labor costs. Leveraging technology and artificial intelligence to optimize operations is one of the most effective measures to reduce costs and enhance value. 

Utilizing a managed services model is another significant opportunity for companies to conduct day-to-day business operations at a reduced cost structure and within an environment geared toward continuous improvement.

How RSM can help with optimization and rationalization

Here’s an example of how a rapid cost takeout benefited one of our clients. A PE-owned tire and automotive repair provider engaged our advisors to conduct a procurement cost savings analysis following an acquisition. They aimed to identify and achieve significant cost savings to enhance the business’s value through increased profitability.

Through a SKU-level analysis of the client and target’s existing procurement mix (e.g., tires, oil and parts) and in-place vendor and distributor agreements (e.g., volume-based incentives, applicable discounts and features), RSM identified and proposed optimal terms, pricing and mix, resulting in actionable annual cost savings of approximately $4 million or the equivalent of a $40 million increase in total enterprise value assuming a five-year exit timeline.

RSM continues to remain busy serving private equity firms and their portfolio companies, and we are hyper-focused on responding to the ever-changing marketplace dynamics caused by macroeconomic and other factors.