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InsightsM&A Advisory

What Happens to M&A During a Recession?

By November 16, 2022No Comments

As inflation impacts the economy, a recession seems probable – and perhaps has already started. While looking at past recessions can provide some insight into what to expect, it’s important to remember that no two recessions are the same and the impact on M&A might be different this time around.

In this article, we’ll discuss the different factors that might affect M&A and the deal-making community during the next recession – and what opportunities might arise for business owners.

What are the main drivers of M&A?

In general, the main variables that drive M&A are:

  • Cost of capital
  • Capacity and appetite for lending
  • Buyer’s access to equity
  • Supply and demand for deals

Now let’s dive a little deeper into those factors in the current economy to see what could lie ahead.

  1. Cost of Capital

The Federal Reserve has raised the benchmark rate five times in 2022, from 0.25% in March to 4.25% in November. If the economy enters a true recession, it is unlikely that the Fed will continue to raise rates. Historically during downturns, they decrease rates or keep them steady.

In terms of M&A, the general rule is the lower the cost of borrowed money, the more a buyer is willing to pay. While the interest rates are higher now than they were last year, they still are lower than historical baselines.

  1. Banks’ Capacity for Lending

Unlike recessions in the past – which had an outsized impact on financial institutions that made lending scarce – this next recession will likely not affect lending capacity in a drastic way. Instead, a slowdown would probably cause banks to be slightly more cautious and conservative when it comes to lending if they anticipate lower earnings.

In terms of general M&A, this means that the less money a buyer can borrow, the less they are willing to pay for a business. However, banks aren’t likely to close their doors to lending, and many buyers have the financial means – and dry powder ready to deploy – to continue to pay top dollar for strong businesses.

  1. Buyers’ Access to Equity

A looming recession will not affect buyers’ cash surpluses too much – at least for the foreseeable future. Strategic buyers are likely to have cash on hand for the initial part of an economic downturn, and financial buyers are usually in a good position to invest as well.

For M&A, strong cash access means the motivation to get deals done. This remains true in an economic downturn.

  1. Supply and Demand of Deals

2021 was unprecedented for M&A in general, with many buyers having huge appetites for deals after the pandemic. As inflation and other factors have slowed the economy down, deal-making has also slowed down a bit. But for good businesses, there will always be demand. And as the outlook for 2023 becomes clearer, we expect to see buyers start to deploy their large reserves of dry powder and meaningful M&A activity to continue.