2016 proved to be a curvy road for many reasons—with mergers and acquisitions experiencing the twists and turns as well. US deal volume cooled down slightly in 2016 with a 22.9% decrease from the prior year, while total deal value was high at $1.5 trillion as the average premium skyrocketed to an 11 times price-to-EBITDA multiple.* With debt abundantly available and interest rates still low, valuations jumped and acquirers didn’t balk at hefty price tags. So the question now becomes: will this shift be more pronounced in 2017? There’s no way to know for sure, but there are some factors to consider.

We at Katten—through deals we’ve done and discussions we’ve had with clients—have noticed some interesting behavior, a few possible trends and several ways middle-market M&A participants are getting ahead. Highlighted below are some thoughts on how dealmakers are approaching deals and some trends to watch.

Financial investors continue to dominate the auction market for acquisitions. Financial investors are still the primary players in active auctions in the middle market. While the low interest rate environment that allows them to pay high multiples is a driving factor, we have seen two other dynamics at play. First, to the extent that strategic investors are using internal resources to perform diligence that private equity firms are outsourcing to third-party consultants that move more quickly, the strategic investors may fall behind in rapidly moving competitive processes. In addition, strategic investors often are not as comfortable with rep and warranty insurance as PE firms, which puts them at a disadvantage as these policies have become the standard price of admission in many auctions these days. These factors have led some strategic investors to avoid auctions altogether. If and when the playing field is more even—perhaps when multiples come back down to Earth or interest rates climb—then strategic investors will be back in the auction game but many of them have become mostly sidelined for now.

Owners/operators’ decisions when picking exit partners often are driven as much by relationship as by price. Perhaps because pricing dynamics tend to generally favor sellers, we’ve seen a number of deals in 2016 where owners/operators have sold their businesses to buyers with whom they had relationships and felt comfortable with them running their businesses, rather than hold out for the highest possible price from strangers. Financial buyers seeking proprietary transactions would be well-served by making sure the soft side of their pitch is just as strong as the pricing, whether by showing a demonstrated track record in the industry, or by teaming with strong management candidates.

Some assets are more valuable as EBITDA components than as sale opportunities. Non-core divisions are often in play as divestiture opportunities that can raise cash for the selling owner. However, with the current valuation levels, a non-core division that can maintain even performance is more valuable on the balance sheet than off, because the equity markets are giving owners credit at higher multiples than a sale would. Of course, the inherent risk is that if the equity markets turn then the dynamic will reverse and pressure will be on to sell in a market that might quickly become an exercise in “catching a falling knife.” In order to act quickly and stay ahead of competitors, companies should consider preparing quality of earnings reports in advance and keeping them updated quarterly. Also, financial and operational due diligence reports that provide a clear roadmap for transition services could be very valuable by shaving days, if not weeks, off of a carve-out sale process. Having these reports at the ready can help companies move quickly when the time is right to sell, and that time-savings could result in a higher multiple for their asset.

Family offices continue to compete with private equity. More and more, family offices are looking and acting like traditional private equity funds. In recent years, family offices have made the investment to hire experienced professionals and that effort has been paying off. Previously viewed as more conservative and deliberate in processes, family offices are becoming more nimble and active (as well as successful) participants in the private equity industry. As family offices become more professional, the families/limited partners are granting more autonomy to the deal teams, thereby enabling more streamlined processes in both proprietary and competitive transaction processes. Look for this trend to continue in 2017 and beyond.

Independent sponsors will play an increasingly important role in M&A transactions in the lower middle market. Capital providers in the lower middle market will continue to look to independent sponsors to find value opportunities. In particular, we expect family offices to partner more frequently with operationally focused independent sponsors in new acquisitions, providing independent sponsors with reliable capital sources and more control over investment and operational strategy at the portfolio company level. In addition, as competition for new acquisitions remains strong, we expect that independent sponsors will continue to command premium economic terms relating to management fees and promotes.

2017 is a year rife for change and there are a number of different ways the next 12 months could shake out—depending on the moves made by the new administration, the impact of the UK’s movement towards exit from the European Union, interest rates and geopolitical events. Uncertainty abounds and dealmakers are eyeing the landscape carefully.

Whatever happens, those that have most thoroughly prepared in advance for possible shifts in the M&A market will be best positioned to succeed—remaining nimble in order to buy, sell, merge or hold. We understand that acting instead of reacting in the face of change can create new opportunities, and we can help you successfully navigate them.