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Capstone Partners Q4 2023 Capital Markets Update

M&A Activity is Poised for a Resurgence

The deal market is in a recession and has been for over a year. It is hard to square that fact with the outstanding public equity market performance in 2023, but the numbers do not lie: middle market (less than $500 million in enterprise value) merger and acquisition (M&A) volume declined 12.8% from 2022 to 2023. Total disclosed middle market deal value took a decisive hit—down 40% and at its lowest figure since 2009. Has the combination of high interest rates and a perpetually impending recession sapped private equity’s appetite for risk? Capstone’s dealmaking in 2023 and early 2024 indicates the answer is “yes.” Deal volumes suffered in part because the sponsors themselves shelved exit processes, acknowledging the likely weakness of a financial buyer bid.

Given the bull run in public equity valuations, the “denominator effect” is off the table for the moment. However, access to capital is still the topic de jour in Sponsorland. The pressure mounts daily on general partners (GPs) to return capital to their limited partners (LPs) to stimulate fundraising. Starting in the fourth quarter of last year, we observed a dramatic rise in inbound inquiry for sell-side advice for sponsor-owned assets. Pitch activity has elevated over 2022 and 2023 levels for the past three months. Capstone launched few new deals in January, but just went to market with a flurry of new product as we go to press in March 2024. Capstone maintains hope that the following conditions will turn the tide of dealmaking in 2024:

  1. Strategic buyers with all-time high valuations will continue to buoy the M&A market by using their expensive stock to shop.
  2. Chastened seller valuation expectations afford dealmakers more wiggle room to find common ground with prospective buyers.
  3. Compression in credit spreads for acquisition financing, coupled with greater credit availability and fewer restrictive covenants, will allow sponsors to hit their target equity returns in new leveraged buy-outs (LBOs).
  4. Perhaps Chairman Powell will help us out with a rate cut or three.

When the market gathers momentum, the conditions exist for an avalanche of deals. In addition to new mandates, investment banks hold failed and unlaunched deals in “inventory.” We expect many of those clients to pounce on any sign of blue skies.

Given the bull run in public equity valuations, the ‘denominator effect’ is off the table for the moment. However, access to capital is still the topic de jour in Sponsorland. The pressure mounts daily on GPs to return capital to their LPs to stimulate fundraising.

Brendan BurkeHead of Sponsor Coverage, Capstone Partners

Total middle market M&A volume declined 12.8% year-over-year (YOY), as caution among buyers and sellers slowed dealmaking. However, middle market dealmaking in Q4 alone fell 4.7% from the prior quarter compared to the 12.1% quarter-over-quarter (QoQ) fall in Q2 2023, highlighting moderation in the pullback of M&A volume on a quarterly basis. The final quarter of 2023 may also provide a glimpse into the improving valuation environment. In Q4, the average deal value amounted to $74.1 million, a 73.2% QoQ increase and the highest value since Q2 2022.

Average M&A valuations in 2023 met prior year levels at 9.6x EV/EBITDA. The valuation backdrop seemed to improve in Q4 with the average quarterly valuation rising over three turns QoQ to 11.2x. Buyers have prioritized profitability and scale, which has allowed quality businesses to secure strong interest. Privately-owned businesses in recession resistant sectors with sustained demand, including Automotive Aftermarket, HVAC Services, and Government Information Technology Services, continued to achieve health M&A pricing. Additionally, average valuations in the core middle market ($100-$250 million) improved YOY to 13.0x—leading pricing across all enterprise value ranges. Targets in the core middle market have tended to be most resilient from a valuation standpoint as they are scaled enough to attract large buyers but not out of reach of smaller strategics and sponsors. Average multiples in the lower middle market ($10-$100 million) declined to 9.1x in 2023 from 9.4x in the prior year. Out of all enterprise value ranges, the upper middle market ($250-$500 million) saw the greatest compression with the average multiple falling nearly a full turn YOY to 11.5x.

Sponsor fundraising remained resilient in 2023. Total capital raised fell a modest 3.4% YOY while fund count declined 36.4%—pointing to established players with proven track records having the most success in raising capital. Rolling one-year internal rate of return (IRR) among middle market sponsors has also improved, rising to 7.8% as of Q2 2023. Sponsors remain armed with vast reserves of dry powder, opting to deploy capital mainly for add-on acquisitions as continued interest rate hikes have increased financing costs for large-scale buyouts.

Private strategic buyers were highly selective in their acquisition pursuits throughout 2023. Strategics have continued to eye acquisitions that offer synergies while private equity firms have opportunistically acquired businesses with proven cash flows, often at discounted valuations compared to prior years. Throughout 2023, many strategic buyers focused internally, fortifying balance sheets, monitoring interest coverage, and bracing for a potential downturn. Closed middle market transactions among public strategic buyers continued to decline in Q4, with volume falling 12.9% QoQ. However, average deal value paid by public strategics in Q4 alone increased 39.4% QoQ to $88.5 million. Deal volume closed by private strategics registered deeper declines, falling 15.1% QoQ in Q4. Average deal value paid by private strategics grew 77.9% QoQ to $84.2 million, modestly trailing average deal value paid by public buyers.

Although middle market M&A experienced a lackluster year in 2023, a less severe decline in deal volume registered in Q4 has pointed towards signs of normalization. While quality companies in defensible industries with strong margin profiles continued to command premium valuations, many private equity firms were hesitant to deploy capital amid an uncertain economic backdrop. A depressed valuation environment also lengthened the holding times of sponsor-backed portfolio companies. However, robust private equity fundraising levels have provided ample resources for sponsors to go on the offensive. Additionally, the Federal Reserve’s ability to communicate a clear strategy for their terminal interest rate will likely influence buyer appetite in 2024. With substantial pent-up demand expected to come to market in 2024, supported by the return of private equity, M&A activity in poised for a resurgence.

Download our full Q4 2023 Capital Markets Update Report Publication:

Request instant access to the full Capital Markets Update for a deep dive into recent Middle Market activity and trends including:

  • Key considerations for middle market business owners regarding dry powder levels, buyer appetite, lending conditions, and M&A pricing trends.
  • Commentary on the primary drivers of transaction volume and valuations through Q4 2023.
  • A breakdown of the top sectors preferred by Capstone’s sponsor network throughout 2023.
  • An overview on equity private capital market conditions, featuring Capstone’s Equity Capital Advisory group.


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