In a highly anticipated move, the Federal Reserve announced an interest rate cut on September 18, reducing rates by 50 basis points to a range of 4.75-5%. This is the first rate cut in four years after interest rates hit a 23-year high. Much speculation swirled around how aggressive the Fed would be on this first cut, and they decided to go big.
This was the move that many dealmakers have been waiting on, and so the big question I am being asked is if, and when, we might see an uptick in M&A activity.
How did we get here?
Following an unprecedented global stimulus to fend off a recession after the COVID-19 pandemic, capital markets and asset prices ballooned, and so did prices for goods and services across the world. During the period starting from the second half of 2020 through the end of 2022, dealmakers saw a flood of mergers, acquisitions, startup financings, venture capital and private equity fundraising, and initial public offerings. But after a 16-year period of a near-zero interest rate policy (ZIRP), central bank stimulus in financial markets, and a three-year binge of government spending, the Fed finally woke up to “Dutch tulips” growing in the front yard.
In response to a brush fire of inflation with no restraint in sight, the Fed began applying the brakes in early 2022 and hit them hard in 2023. They embarked on the fastest program of interest rate increases in the history of the United States that equaled an increase of 500 percent in one year. Simultaneously, the Fed stopped its program of “quantitative easing”, or open market purchases of U.S. government bonds and other similar measures, that restricted liquidity in financial markets.
All of this resulted in investors seeking safety in high yielding U.S. government treasury bonds and similar financial instruments. The cost of capital required to acquire a business skyrocketed, and the funds required to do so became scarce. Inevitably, the IPO market dried up.
At the same time, in a perfect storm for deal makers, U.S. government regulatory authorities also implemented a crackdown on corporate mergers and acquisitions starting in early 2022. Regulators began targeting the technology industry and announced it was blocking deals across other industries, from aviation to fintech. In a stunning display of regulatory chutzpah, the chair of the Federal Trade Commission (FTC) implemented merger control guidelines that put the industry on notice that FTC review of deals, and indeed the FTC’s remit, would extend beyond ensuring fair competition, to include impacts on labor, employment, diversity, climate change, and other extra-statutory political goals.
This caused mergers and acquisitions to slow to a trickle. The combined forces of higher cost of capital, decreased liquidity, and regulatory restrictions, worked together to stop deal making, which like dominos lined up in a row, knocked over the next one. You see, absent robust M&A and IPO markets to recycle capital for investors, investment in new startups has frozen up, and fundraising for venture capital and private equity has necessarily slowed. It has been a multi-year-long winter for Wall Street and Silicon Valley. While big tech stock prices have done well, the market for venture capital and startup investment has become depressed. Eventually, the Fed’s coordinated actions had their desired effect on inflation, which is back down in a range of acceptable. Meanwhile, employment growth has slowed, and the Fed has margin to maneuver once again.
Where are we going now?
The technology industry has seen the greatest boom and bust cycle over the past five years that I may yet see in my lifetime. Meanwhile, the potential for artificial intelligence to disrupt every industry and every aspect of technology has inspired the investment of historic levels of capital, from startups to big tech. But if deal making activity doesn’t start de freezing soon, this will not end well.
So, the fact that the Fed decreased rates by a half point rather than a quarter point bodes well. A recent article by PitchBook notes that with this rate cut, the appetite for dealmaking should ramp up as borrowing costs are reduced, and several more rate cuts are expected in the coming months. CNBC reports that the Fed’s “dot plot” indicates they could cut another 50 basis points by the end of the year as well as a full percentage point cut in 2025. So, dealmakers are looking at a series of reductions that could have significant impacts on the M&A environment.
With an improvement in the overall M&A landscape, startups could also start to see increased competition among buyers for the same targets, which could drive up prices. They could also see their valuations rise, something that many founders have been hoping for. There could also be an uptick in private equity activity, as lower interest rates make leveraged buyouts a more attractive option.
Their data shows that in the first half of this year, there was an estimated $1.47 trillion in deal volume. That is 41%less than the two-quarter peak of $2.47 trillion in Q4 2021 and Q1 2022. But the tides are already turning across the pond. Some European banks already cut rates in Q2, leading to a 17% rise in M&A deal value in that quarter vs. Q1.
If the European data is any indication, there could be at least some level of the M&A rebound everyone has been waiting on, especially if the Fed continues to drop rates as projected.
However, as PitchBook points out, do not have high expectations for a return to the era of zero rates. Chairman Powell has said they will not be going that far.
Meanwhile, the term of Federal Trade Commission Chair Lina Khan has expired. Unlikely to be replaced by the current U.S. President before he leaves office, a new president, no matter which party wins, is widely expected to appoint someone with a less expansive view of the remit and a mandate to restart dealmaking activity. The speed at which a new administration springs into action and the direction remains to be seen. All of this is to say that while we might not see a complete return to the flurry of activity around 2021, we will certainly see an uptick as dealmakers get off the sidelines with fresh capital and the blindfolds off.
Founders should be prepared, evaluating their potential exit strategies and looking at how to best position their startups for a potential acquisition. But remember, just because there is an increase in M&A activity, doesn’t mean it is the right time to sell. Timing is everything, and founders must consider many factors such as their long-term growth trajectory and current market conditions.
