Observations from Two of SoCal’s Leading Transaction Attorneys

What can buyers and sellers expect from the M&A market in 2024? Procopio Mergers & Acquisitions and Strategic Joint Ventures leaders Paul Johnson and Jason Femrite break it down in this Q&A interview.

Q: How does the 2024 M&A market outlook compare to 2023? Any positive trends?

Johnson: The total number of deals last year was still fairly high compared to recent years, but the aggregate dollar value was down. There were economic pressures pushing valuations down, which somewhat but not completely suppressed activity. There are signs it will improve. Bankers are starting to get busier, calendars are filling up. We probably won’t hit higher numbers until Q2 or Q3, but I expect things to pick up.

Femrite: I’d agree 2023 was slow. Deals were taking far longer to get done if they were getting done, and there still weren’t as many new deals last year as there had been in previous years, but also I’m hopeful.

Johnson: There has been a lot of volatility, people not knowing where the markets are going. When there is uncertainty about the valuation of companies, reflected by public market volatility, then people don’t know how to price deals. With volatility falling and the Federal Reserve not of a mind to continue increasing interest rates, the economic picture is solidifying enough that I think more people will be confident about moving forward.

Femrite: The credit market has been a big factor. The cost of money has a real impact on a lot of deals getting done. Several buyers had significant problems getting financing because of it. It took longer and it was more difficult to access capital in order to close transactions.

Johnson: There is still a historically high amount of dry powder sitting on the sidelines, by one measure $1.4 trillion in private equity (other measures report more), which is just roughly 40% more than in 2020. That’s unbelievable.  That would ordinarily be expected to prompt more deals.  In addition, some private equity funds are long enough in the tooth that they may look to sell portfolio companies as opposed to buying.

Q: Are there other M&A trends we should be watching?

Femrite: One trend we should talk about is the number of indemnity claims and rep and warranty insurance claims that are coming out. It seems like buyers, in particular financial buyers, are more willing to make claims than I’ve seen historically. That may just be my perception, but in most of the studies I’ve seen there’s been a fair percentage of deals that now have claims, with purchase price adjustments becoming normal. I don’t know if that’s because valuations have been high and there are a lot of buyers with remorse, but it certainly seems as though they’re willing to pull the trigger on indemnification claims in a way that I hadn’t seen before.

Q: Is that a trend you’re taking into account when working with a seller?

Femrite: One of my favorite statements by Paul is that our job is to make sure that the value that an entrepreneur has created in their company doesn’t leak out as part of the transaction. But now we have concrete evidence of how claims are being made quite a bit on financial statements. So it definitely seems like that’s bearing out in the actual market, whereas in the past, I think buyers were more reluctant to make claims.

Johnson: One of the advantages for a buyer in getting insurance is that if a buyer makes a claim against the insurance, it’s not necessarily angering its new employees as much. If that same buyer had a 10% escrow of its new employees’ money as security for claims arising out of the acquisition (the typical amount for uninsured deals), making a claim could damage relations. But if the employees have half a percent or less of the deal at risk (the typical amounts of escrows in insured deals), employees care a lot less about the buyer making that claim.

Q: Are there industry sectors that may see more activity?

Johnson: Last year tech was big. It’s widely known in the public market that there were a few tech companies that drove the increases in market value, and tech may continue to do well generally. There’s still a question mark when you get beyond big tech, Alphabet or Meta or Tesla. We’ll have to see how tech will do in M&A as a result, but it’s an interesting place to look.

Femrite: The consumer goods industry has been down for several years. I’ve talked to a lot of investment bankers in that space and most of them have seen a downturn in transactions over the last 12 to 18 months. With inflation the price of goods has gone up, and it’s been more difficult to get product in because of continuing supply chain issues since Covid. That has made product far more costly or difficult to come by, and all of that has affected the industry.  I’m hopeful that industry is coming back, but we’ll see.

Johnson: As for life sciences, it’s been bad. There’s nowhere to go but up. I’ve heard some optimism the public markets will start opening up for life sciences, so that could pave the way for more investment on the M&A side.

Q: How does the market look in Southern California in particular?

Johnson: I think here in SoCal you’ll see us following the national trends, what you see in New York and Silicon Valley, but we may lag a month or two as the national trends sometimes take time to hit us here.

Femrite: Agreed.

Q: If I’m an entrepreneur and am considering an exit, is this a good time for me to be doing that?

Femrite: It depends upon the company and the industry, but it’s certainly the right time to have a conversation with the people who know the market for the industry and type of business. I always recommend people talk to investment bankers early and often to gauge the market. Waiting is a problem because you might miss your window. Some say, ‘Oh, I’m going to build my business for another year or two,’ and the market drops out, or their business has an issue. They lose a ton of value and then they end up selling for significantly less than they could have if they had performed a market check earlier on.

Johnson: The good news about investment bankers is that they love to meet you and it’s free to have a conversation with them. You don’t get charged until you engage in an official process, and they get paid the lion’s share of their fee at the closing. So having a conversation with the right investment banker is always a good idea. And it’s good, like Jason said, to talk to the ones who know your space, the ones that can open doors for you. A good investment banker will tell you if it’s not the time to sell, if you should spend a year or two building up your earnings. You could get some multiple of that back in a year or two, or you could miss the window as Jason said.  A good banker helps you navigate those waters.

Femrite: You should definitely be building your network well in advance of a sale.

Johnson: We have a good relationship with investment bankers and facilitate conversations all the time.

According to Paul and Jason, volatility in the public markets has dampened buyer enthusiasm in the private markets, but more stability in the stock market and with interest rates could encourage the release of pent-up investment funds. Regardless of where an entrepreneur is in the growth of their company, it’s a good time to start discussing a possible exit with legal counsel and investment bankers.