Capstone Partners Q2 2022 Capital Markets Update

Middle Market M&A Withstands Economic Volatility

The U.S. economy has found itself in a precarious position through the first half of the year. On the heels of an additional 75-basis point interest rate hike, consecutive quarters of GDP (gross domestic product) contraction have led many market participants to reason a recession is underway. Volatility continues to ripple through equity markets in response to tightening monetary policy and economic uncertainty. Meanwhile, four-decade high inflation has placed an increased focus on cost controls to defend profitability, echoed across public company earnings calls. Middle market business owners have overwhelmingly indicated that rising costs have fueled their uncertain economic outlook, with 87% of CEOs experiencing negative inflationary impacts in Q1, according to Capstone’s Middle Market Business Owners Survey. However, growth strategies remain in focus as nearly 30% of middle market business owners planned to engage in an acquisition in Q2—pointing towards strong fundamentals across the mergers and acquisitions (M&A) market.

Thus far, 2022 has served as a tremendous testimony to the resilience of middle market America and the related M&A environment…2021 presented a valuation tide that floated all boats—2022 is a more selective market.

John FerraraFounder & President, Capstone Partners

Middle market M&A volume has remained healthy despite persistent economic headwinds, although it has not matched 2021’s record level of activity. Transaction activity through Q2 fell a modest 3.4% year-over-year (YOY) as sellers of privately-owned businesses continued to see substantial strategic and private equity (PE) buyer interest.

Strategic and private equity buyers are increasingly assessing potential target companies’ defensibility and margin sustainability. This has not prevented buyers from allocating healthy sums to win businesses. Through Q2, the average deal value has increased 2% YOY to $67.8 million. On the other hand, valuation multiples have declined to an average of 9.2x EBITDA in Q2 from the full-year 2021 average of 10.7x, partly owed to increased financing and input costs. However, Q2 multiples have surpassed Q2 2021 by a modest 0.2x. Average valuations at the “core” middle market ($100-$250 million in enterprise value) have revealed an interesting dynamic. Valuations increased two full turns to 12.3x EBITDA from 10.1x and exceeded the average multiple of 11.8x at the upper middle market ($250-$500 million). This supports the thesis that amid uncertainty, larger buyers will often move down market and fuel competition for smaller businesses. Moving through the second half of 2022, the valuation environment remains unclear. Buyers are carefully factoring in supply chain challenges and inflationary costs to earnings projections. Regardless, a strong collection of financial and strategic buyers remain active in the market, with high-quality assets continuing to transact at premium multiples.

Private strategic buyers continued to account for the majority of closed middle market transactions, comprising nearly 64% of deals through Q2. While private strategic volume fell 6.1% YOY, the average deal value increased 5.3% to $66.7 million. Public strategic deal flow has registered deeper declines, falling 22.6%—potentially reflecting a more cautious playbook for inorganic growth amid a potential economic downturn. Average deal value paid by public strategics followed a similar trend as private strategics, rising 3.8% YOY to $69.6 million. Among international buyers, dealmaking has trended lower through the midpoint of the year. Russia’s war on Ukraine, supply chain uncertainties, and security issues have stifled transaction activity, with acquisitions by foreign buyers falling 15.2% YOY. The strengthening of the U.S. dollar against world currencies has also reduced the purchasing power of foreign buyers, making domestic assets more expensive. A stronger dollar will continue to play a significant role in foreign acquisition activity and will likely weigh on valuations in the near term.

Private equity firms have been more selective in their acquisition pursuits through Q2 which has contributed to the 27.4% decline in middle market closed transactions by sponsors. The unprecedented surge in private equity activity in 2021 also makes for a complex YOY comparison. While the decline is notable, private equity deal activity remains healthy relative to pre-pandemic years. Rising interest rates, while still historically low, have made leveraged transactions more expensive, emphasizing the importance of robust free cash flows of a potential target as general partners (GPs) seek to meet internal rate of return goals. As private equity exits have slowed, GP-led secondary transactions have emerged as a useful value-creation tool for sponsors with high-performing assets. The prevalence of these continuation vehicles, which serve as an attractive alternative to an exit from a portfolio holding company, is likely to increase in the near term.

Recession labels for the current environment have been undermined by the strong U.S. labor market which added 2.7 million jobs in the first half of the year, with the unemployment rate standing at 3.6%, according to the U.S. Bureau of Labor Statistics. What does this all mean for privately-owned businesses exploring a liquidity event? The M&A markets remain open, absent of any drastic declines in activity that would point to a systemic weakness. Buyers are hungry for quality assets but are increasingly assessing targets through the lens of a downturn. Economic uncertainty tends to drag down dealmaking and valuations, however, middle market M&A activity has demonstrated resilience in the first half of the year. Headwinds to economic growth and deal activity will persist through the end of the year and into 2023, but the middle market remains well-positioned to weather the storm.

Download the full report:

Request instant access to the full report below to review our 2022 Middle Market Outlook and commentary from Capstone Partners' Founder & President John Ferrara, as well as an update on recent Middle Market activity and trends including

  • M&A Amid Economic Cycles
  • Quarterly M&A Volume
  • Pricing Trends
  • Strategic Acquirer Activity
  • Private Equity Activity, Preferences, and Valuations
  • Capstone Barometers


Related Transactions

Insights for Middle Market Leaders

Receive email updates with our proprietary data, reports, and insights as they’re published for the industries that matter to you most.