Key findings and analysis
It’s a positive sign for the sector that deal volumes in 2023 remained ahead of pre-2021 levels. The volume of M&A activity was heightened across the wider market throughout 2022 partly as a result of pent-up demand post Covid-19. While it may not look like the most positive year for M&A in the recruitment sector when compared to the past few years, the trends in 2023 reverted to a pattern reminiscent of pre-2021.
Despite inflation, high interest rates, political uncertainty and global conflicts, 2023 has shown good transaction volumes for the long run. Will this trend persist into 2024?
The level of transaction activity in 2023 was largely driven by a strong Q1, as well as a good Q4. This was partly due to strong momentum from 2022, particularly owing to an increased lag in deal completions. This meant deals initiated in 2022 were finalised in Q1 of 2023.
The number of transactions in Q2 of 2023, however, were significantly lower than in any other quarter. We believe this arose from the choppier environment, resulting in buyers taking a ‘wait and see’ approach. Strong performance in the sector in 2021 and the start of 2023 began to show signs of weakening by Q2, which continued throughout the second half of 2023. Hiring slowed down in some sectors, impacting the financial outlook of recruitment firms, which made them less attractive acquisition targets. In addition, lenders and investors became more cautious about financing M&A deals in the face of economic uncertainty, which led to stricter due diligence processes and higher financing costs, further dampening deal activity. Towards the end of 2022, and throughout 2023, a number of deals fell through as recruitment firms struggled with low trade and the need to manage costs.
Deal transactions by quarter from 2020 to 2023
Despite low transaction volumes in Q2, investor confidence rose in Q3 and Q4 even as interest rates reached their highest level last year. They have now stabilised, and there are increasing signals that rates have already reached their peak. This has been matched by a relative rise in deal volumes. A key issue in 2023 has been poor labour supply and the ‘war for talent’. As such, acquisitions of businesses with strong teams allows business owners to de-risk. This has been a key driver behind vendor decision-making in the second half of 2023. Furthermore, the economic downturn at the start of the year led to weaker players exiting the market, creating attractive acquisition opportunities for strong players. Private equity remained active, primarily through strategic bolt-on acquisitions to expand geographically or into specific sub-sectors. The level of private equity involvement in deals notably increased in 2023 to 35.4%, a significant increase from 21.7% recorded in 2022.
Leveraged deals were on the decline given the continued escalation of interest rates, marked by five base rate rises in 2023, from 4% to 5.25% taking the base rate to the highest level since 2008. This rise in interest rates has diminished the attractiveness of debt financing, with the resulting pressures beginning to impact the broader economy.
We’re aware there has been, and continues to be, a disconnect between value expectations and the transaction data that we’re seeing. Despite the wider concerns about the economy, it’s clear that good businesses with strong teams remain attractive. There is capital in the marketplace and with the cost of debt increasing, private equity involvement has risen. It’s certainly clear that there is increased confidence in the market, partly driven by the stabilisation of interest rates, and investors with cash are starting to recognise that this is a good time to deploy funds and invest.
During the past year we’ve found that the average time taken for deals to complete has risen, as more in-depth due diligence is required for all involved parties to gain comfort on what is being agreed as part of any transaction.
We’ve also seen an increase in earn outs across all sectors due to more uncertainty and volatility in the market, especially where there is an expectation gap between target and buyer. The inclusion of earn out mechanisms means buyers de-risk the transaction. We’re seeing that a higher proportion of the total purchase price has been paid via earn out mechanisms (around 30% and up) as opposed to the lower levels previously observed.
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