Investors, deal professionals, and others working in the M&A markets are eagerly looking for signs of a recovery which will lead to normalized levels of activity.

The biggest question that looms large is what constitutes a normalized level of M&A activity. The overall consensus is the unprecedented activity starting in the second half of 2020 through 2021 and early 2022 was a career lifetime event and an outlier fueled by cheap money, strong consumer demand, and record amounts of capital. 2023 was horrible – uncertainty around interest rates, high inflation, an IPO market that was closed for business, and tight credit markets all contributed to another career lifetime event. But unlike 2020, one that headed in the wrong direction. 

So, what is in store for 2024? Halfway through Q2, the mood in the marketplace is one of cautious optimism. There are signs that we are moving past the worst of it, although this is yet to translate into a consistent trend that creates the ability to predict what the rest of the year will bring. 

Deal makers in private equity are highlighting the following trends: 

• A level of certainty around operating in a higher interest rate environment which is expected to remain for an extended period of time. The pendulum swings weekly as to whether or not there will be one or several rate cuts this year, or none. Even if there is an interest rate cut, it is not going to move the needle in terms of impacting investment returns. One thing is for sure, 2024 is not reverting to the interest rate levels we saw during 2015-2018 and during the pandemic. 
• LPs require their investments to turn over so they can reassess their allocations, as well as drive their own returns. The slow-down in deal activity has delayed this leading to a domino effect – without a return on investment and liquidity, LPs are not able to redeploy funds into private equity and therefore are less likely to support new managers. Our clients are telling us the fundraising environment is the toughest they have seen in years. Long term, this does not bode well for private equity markets. 
• LPs are putting pressure on funds to sell assets, even if the returns are not what investors are hoping for. The use of continuation vehicles, which started to gain traction last year, continues to be an exit strategy. 
• Record amounts of dry powder are still out there. Private equity investors need to deploy the capital, and, for many investors, the clock is ticking in their fund life – they have lost  up to 18 months. No one wants to return unused capital to LPs. This does not reflect well and makes it harder to raise a fund next time. 
• Access to credit markets is improving, especially in the core middle market and upper middle market. Many private credit funds I have met with recently have complained about the competitiveness and the availability of capital, especially for high quality deals. 
• Gaps in valuation expectations between buyers and sellers are starting to narrow, although it is still not where it needs to be. However, as time goes on and market forces converge, more sellers are less willing to wait on the sidelines. They are engaging bankers and entering the market to launch their processes. Valuations and demand for high quality assets are still high. We have heard from sellers whose competitors have consummated transactions at hefty valuations since they feel compelled to launch a process which is creating momentum. 
• Financial re-engineering as a single lever to drive value in M&A transactions can no longer be relied upon to generate strong returns. Instead, private equity managers are putting more emphasis in driving operational efficiencies through performance improvement and value creation initiatives including costs take-out and optimization, innovation, and revenue and top-line growth, to name a few.
• Investment banks continue to have strong pipelines and are seeming to move more steadily towards launching a process. It will take time to move deals from the “pipeline” to “active” status. While this creates a lag in overall activity until deals start to move with a regular cadence, we expect to see a pick-up in overall activity.  
• The stock market is showing strength, with all indices achieving record levels. Overall spending is proving resilient, leading to high corporate earnings that have exceeded expectations. Innovation and AI are leading to more efficiencies which are creating favorable tailwinds. 

All of this still does not answer the big question: What constitutes normalized activity that allows investors and other stakeholders to actively predict and plan for their business? It is hard for investors to execute on a strategy around the number of deals and size of equity checks to deploy in any given year, as well as make investments in resources and technology without knowing where things are headed. 

Without a crystal ball, perhaps we can look back to the period of 2017-2019 as being representative of normalized market trends. In simplified terms, there were no significant geopolitical events. The chaos and aftermath of the 2020 election was not anticipated. Added to this, inflation was relatively contained averaging around 2% over those years, the Dow Jones and M&A activity increased at a steady pace, and interest rates fluctuated between 3-5% in that period. 

Hopefully, by the end of this year, we will have a clearer path – but for now, it is going to require some level of patience and calculated risk taking.