Based on analyst reports and Citizens Annual Middle Market M&A Outlook, 2022 is expected to be another high-paced deal year.

David Dunstan managing director in Citizens M&A Advisory Group, says it's been a long run of strong M&A activity in the last several years. The primary factor that has been and will continue to drive activity levels is the significant amount of capital that's chasing deals. That capital is in the private equity coffers as well as on corporate balance sheets.  

"In fact, 2021 was the second-greatest amount of capital raised by private equity in history," Dunstan says. "So, the dynamic of significant capital chasing deals is really exacerbated by additional capital that's continually being raised, as well as deployed, but being raised at record levels. So, it's a very attractive environment driving demand to acquire companies."

Another expectation is that company valuations will remain strong. Dunstan says the significant demand to acquire businesses based on the capital that's been raised is chasing a limited supply of high-quality companies in the market. With greater demand and a limited supply, prices tend to go up. Still, the survey data suggests there a very bullish attitude with regard to buyers of businesses going into 2022.

"There's a lot of data around the volume of dollars," he says. "There's a lot of data around the supply of companies available. And then there's the sentiment of the decision-makers at private equity- and company-owned businesses where people want to be aggressive, they want to be buyers, and they want to grow and diversify in that manner. That's really driving valuations to record levels as well."

The higher valuations of these companies have buyers working to ensure they're getting returns on their investment by taking bets into sectors where the buyers have strengths. In some cases, they could have confidence because of a prior or existing holding, or a private equity group might have an executive in residence who is essentially an expert in that sector.

"What we found when we are bringing companies to market is the private equity groups that had a real angle, that really understood the business, they were being aggressive," Dunstan says. "They were bidding aggressively, but they weren't bidding on things that were tangential. They were targeting and focused, and that helps with your returns. You can afford to pay a higher multiple if you understand the business, know how to grow the business, to optimize the margins, to expand the market and to do acquisitions of smaller companies at lower multiples, and dollar cost average into an overall evaluation that makes even more sense over time when you look to exit. Strategics played a similar role, really targeting sectors, the niches that were complementary to their business and not fishing expeditions on anything that isn't really core and key to their corporate strategy."

However, 2022 has had its share of turbulence — from inflation, interest rate hikes, the conflict in Ukraine, as well as carryovers from the previous year such as labor and supply chain issues.

Dunstan says each of these has a role. Companies in the industrial sector, for instance, have had shortages of supply. Raw material prices spiked aggressively throughout 2021, and there's a shortage of workers in many cases and labor rates continue to climb in almost every industry sector.

"That certainly can create significant pressure on a business owner trying to navigate those dynamics," he says. "And as we finished up 2021, there started to be some clarity. Companies almost across the board raised prices, customers were accepting of those prices, and we were starting to see margins return to some level of normalcy. And then the Russia-Ukraine matter presented itself and threw another curveball at business owners."

Dunstan spoke on the Smart Business Dealmakers Podcast about the M&A environment in the U.S. and what buyers and sellers could expect based on those conditions for the balance of the year. Hit play to catch the full interview.