The M&A market experienced an exceptional boom in 2021-2022, with robust activity and record-breaking deal flow in the wake of the COVID-19 pandemic. However, in late 2022 and moving into 2023, the market has cooled. GHJ’s Transaction Advisory Services Practice is now seeing scarcer, more expensive capital, increased scrutiny from potential buyers and advisors and longer timelines to execute transactions. All of these factors have led to an evolving role for Quality of Earnings (QoE) reports.
CHANGING MARKET CONDITIONS
Increased interest rates and the slowdown of the bull market have contributed to a decline in the total number of transactions, as well as discounted valuations.
As the Federal Reserve has raised rates and the market prepares for a potential recession, private equity groups and venture capital firms have been more cautious about allocating their resources and have had increased difficulty accessing sufficient capital when they do identify a potential deal. According to Bain & Company, this led to the overall global M&A value dropping 44 percent in the first five months of 2023 relative to the same period last year. This is largely driven by a slowdown in the strategic market, where private equity transaction levels have declined twice as fast as corporate M&A.
INCREASED CAUTION AROUND TRANSACTIONS
The uncertainty and aversion to risk in the current economic climate underline the importance of diligence. Deal advisory teams are an essential resource in providing transparency surrounding financial performance and in preemptively identifying risk areas. A Quality of Earnings report plays a crucial role in mitigating risk and providing relevant information and analysis about a target company. Therefore, in this uncertain market, its role has become even more essential.
Buyers who were previously eager to close deals as quickly as possible in the hot and competitive market of 2021 and early 2022 are now approaching transactions with increased caution. By providing a thorough and comprehensive overview of a target company's financials and operating performance, deeper diligence helps validate buy-side investment theses.
INCREASED DUE DILIGENCE REQUIREMENTS
The post-pandemic landscape has led to increased due diligence requirements as buyers seek to thoroughly assess the financial health and viability of target companies. As a result, scrutiny on financial performance has heightened, necessitating a detailed examination of historical data and potential risk areas. This has lengthened the overall timeline to execute proposed transactions.
Additionally, many corporate and strategic buyers are opting to “roll forward” diligence processes to ensure that the target company’s financial performance stays on track and is not severely impacted by developments in the market. These roll-forwards primarily serve to provide all parties with the most up-to-date and accurate information throughout the longer decision-making process. Extending the analysis period in scope ensures that financial information remains up to date despite lengthier transaction timelines.
The M&A market is inherently cyclical, so recognizing and adapting to changes in expectations, trends and timelines is essential for professionals in the M&A space. While the overall number of transactions has declined relative to 2022, the importance of Quality of Earnings reports in providing assurance and up-to-date analysis of financial performance is increasingly imperative. This heightened importance applies not only to the decision-making process for proposed transactions but also to securing financing in today’s tightly constrained capital market.
To learn more about Quality of Earnings reports and the shifting M&A market, please contact GHJ’s Transaction Advisory Services Practice.