After a record-breaking year for M&A in 2015, this year wasn’t expected to have the same volume of mega deals as Kraft Heinz or Anheuser-Busch InBev and SABMiller. But 2016 may have turned out to be even slower than many industry experts predicted.

“There are lots of deals out there, but the deals are not closing nearly at the rate they were in '14 and '15,” Ben Rudman, director at SDR Ventures, told Food Dive.

Some may wonder why food and beverage M&A deal counts and values are down, as well as what factors encourage healthy M&A activity across the industry.

“Sometimes the factors that drive M&A are not necessarily the typical capital market factors that you might think about,” said Rudman.

Innovation (Or, if you can’t beat ‘em, buy ‘em)

The promise of innovation that startups offer potential acquirers is often a major driver of food and beverage M&A. When innovation runs high, increased allotments for VC investments and acquisitions often follow as major manufacturers seek out more ways to improve top-line growth.

“The newer brands populating the perimeter of the store are killing it from a grocery prospective,” Anthony Valentino, deputy editor at Mergermarket, told Food Dive. “They have the brand loyalty, and they can grow quickly.”

“Consumers are shunning the big guys, so that forces them to acquire,” Valentino continued. “They could innovate, sure. But for the big guys, innovation is not really their nature — they are better at finance, branding and manufacturing. They are leaving development for some of the smaller companies and letting them take on the challenges. And when they're ready, they'll pay the FDCs or the heavy multiples of those companies.”

Rudman cites plant-based ingredients as an example of how innovation drives food and beverage M&A.

“They have been around for 20 years, but there hasn't been a bevy of M&A activity for the last 20 years in plant-based ingredients and food brands,” said Rudman. “In the last five or so years, innovation has been such that those products taste good now. Consumers wanted to eat healthier but they weren't going to give up on taste. Suddenly, they don't have to, and so (manufacturers are) going to adopt those products.”

Consumer demand

Consumer demand also continues to be a key driver for M&A activity, particularly in the food and beverage industry. Currently, the primary motivator for M&A activity seems to be the healthy living aspect that many consumers — and nearly all brands — are focused on right now, Valentino said.

“Practically every macro trend or decision being made has come down to what the consumer wants,” said Valentino. “It results from a pure fundamental shift in how consumers are viewing and even just walking through the supermarket. The center of the store is no longer the focus (for consumers), but the center of the store is where pretty much all the big guys are concentrated. So, that in itself ends up being very healthy for food M&A.”

Acquisitions by major manufacturers like McCormick (Garden Gourmet chilled herbs) and Campbell (Bolthouse Farms, Garden Fresh) reflect how companies are using M&A to address consumer demands that may be more difficult or costly to pursue in-house.

Healthy balance sheet

Access to capital remains a critical contributing factor to a healthy M&A environment for food and beverage companies. Many larger manufacturers have launched dedicated venture capital arms to set aside funds and invest in potential acquisition targets.

Others have enacted more stringent cost-savings initiatives, such as zero-based budgeting, to boost profitability and channel those cost savings into investments and acquisitions. Manufacturers have started to realize that by improving their bottom line with savings initiatives that offer long-term benefits, they can also improve their top-line growth.

Those savings can be invested in acquisitions of startups and companies that are established in the segments in which they want increased presence and visibility.

Manufacturers could also reroute those cost-savings to internal R&D — and many still do. But some innovations are easier and more cost-effective to acquire than to develop in-house, especially if the balance sheet supports it.

Supply of acquisition targets

Even if innovation and consumer demand motivate manufacturers and they have the balance sheet to support M&A activity, they still need a healthy supply of acquisition targets to choose from. And among those companies, they need owners who are willing to sell their businesses to a major corporation, which many startup founders — particularly in younger generations — try to avoid.

Rudman posits that baby boomers, which he calls the largest and most prosperous generation, own many businesses in the food and beverage industry. As this generation gets closer to retirement age, it could increase the number of businesses that must be sold as their owners exit the industry entirely.

“Sure, there are at least some generational transfers, or some people will do ESOPs or sell to their employees or management teams,” said Rudman. “But if baby boomers on average right now are at 52 to 70, in 10 years they're going to be 62 to 80. They're going to sell those businesses at some point, and that's going to be a factor in M&A activity.”

Political climate

Even when the acquisition target supply is bountiful, companies may not be willing to sell based on consumer confidence and political climate. Due to the divisiveness of this year’s presidential and congressional elections, not all sellers felt the time was right this year.

“Some of the middle market guys are mentioning that they have had a lot of family-owned businesses that were basically saying, 'Yeah we're not ready to go just yet. We want to see how things play out with the election,'” said Valentino. “Now, what's interesting about that is that the effect (of the election) on food businesses is muted (compared to other industries), so it's kind of confusing as to why they would want to hold out.”

“That was a response that I got from a lot of people,” Valentino continued. “The pipelines were full and they were seeing quite a few people say that even the election was, not a crutch, but a reason for not going to market just yet.”

The consistency of innovation and consumer demand, as well as predicted improvements to balance sheets, acquisition target supply, and political climate, are expected to contribute to an overall healthier M&A environment for the food and beverage industry in the new year.

“Maybe deals took a hit in Q2, Q3, Q4 2016, but who knows?” said Rudman. “2017 could bring a pretty robust Q1 and Q2.”

The "A Balancing Act" series is brought to you by BMO Harris Bank, a leader in commercial banking. To learn more about their Food & Beverage expertise, visit their website here. BMO Harris Bank has no influence over Food Dive's coverage.