Fractious Financing: Can Dealmakers Solve the Financing Puzzle?

Dealmakers were dealt a challenging hand in 2023. M&A and buyout deals fell year-on-year, both for sponsors and strategics, with a deal volume and value down 15.8 percent and 16 percent year-over-year, respectively.

While there are several factors determining dealmakers’ fates, a persistently high interest rate environment was a major cause for this slowdown. As central banks raised interest rates to combat spiraling inflation, financing for deals became increasingly expensive. Recession fears only added to a hesitancy among banks and institutional investors to fund transactions.

With their core business model dependent on readily available finance — at a favorable price — PE dealmakers bore the brunt of these surging borrowing costs. As a result, deal volume within the industry dropped to its lowest level since 2017.

Outlook: uncertain

Interest rates remain elevated across most jurisdictions, offering little comfort for executives craving some clarity for the year ahead. The Fed, ECB and Bank of England are all holding rates at the start of 2024 as they attempt to get a handle on inflation.

According to the 2024 SS&C Intralinks Global Sentiment Report, financing is set to be the most complex part of the dealmaking process over the next 12 months. Almost a third (31 percent) of respondents expect this to be the case — a figure that rises to 54 percent among Latin American respondents.

Financing conditions are expected to worsen over the year according to a sizable 71 percent of respondents. While high, this figure is a notable decline from the 81 percent who said the same a year ago.

A cause for optimism

However, there are signs that financing conditions could gradually ease over the course of 2024, producing a friendlier deal climate.

All eyes are on the Fed, expected to be the first mover in lowering interest rates, which has pledged to cut interest rates three times in 2024. While progress on inflation will not be linear, U.S. central bankers are said to be working toward­ rate cuts over the summer months. Once the ball starts rolling, the ECB and Bank of England will likely follow suit.

A rally in stock prices indicates an underlying optimism in the market. The S&P 500 rose by 25 percent in 2023, while the tech-focused Nasdaq soared by 44 percent as inflation begins to normalize and recessionary fears subside.

Solving the financing puzzle

Dealmakers have plenty of financing options at their disposal over the coming year, although they may need to get creative.

Private equity firms have amassed a record USD 2.5 trillion in cash reserves. They will be waiting in the wings, ready to capitalize on high-growth deal opportunities once the deal climate improves. Pressure from limited partners to deploy reserves is building, setting the stage for a potential surge in deal activity over the coming months.

Strategics have also chosen to shore up cash rather than spend. U.S. corporate cash levels have risen to a record high of USD 4.15 trillion — almost 50 percent above pre-pandemic levels. They will be keen to put this war chest to work once monetary policies loosen and the economic climate brightens.

Banks are also poised for a comeback. While traditional lenders largely retreated over the past few years due to recession fears and high interest rates, the prospect of a more benign financing climate is drawing them back in. This should provide a cheaper option than non-bank lending — such as direct lending and other types of private credit — that rose to prominence during the high interest rate era.

High-grade bond issuance, meanwhile, has risen to record highs, fuelled by a resurgence in M&A financing. A spike in activity at the start of 2024 bodes well for future dealmaking.

Green shoots emerge

It would seem that the fears that the financing environment will worsen over the coming year could be misplaced. Cash and dry powder for deals are at record highs, while private markets are opening up.

With the anticipation that banks are set for a return to the deal table, and the long-awaited reduction in interest rates penned for mid-year, a resurgence in large, transformative deals could be just around the corner.

The 2024 SS&C Intralinks Global Sentiment Report can be downloaded here.