Which are the Current Opportunities and Challenges in Closing a Middle Market Deal?

By John J. Koeppel

June 13, 2016 | Corporate Blog

Buyers are hungry for acquisitions in today’s market.  Some statistics from the 2016 Pepperdine Capital Markets Report[1] provide a deeper dive into what investment bankers, sellers and buyers (both private equity and strategic buyers) are seeing in the current deal market: 

  • Industries: Private equity buyout respondents indicated a diverse range of industry targets, with the most targeted industries being Business Services (18%), Manufacturing (17%), Wholesale & Distribution (12%); Health Care & Biotech (11%); Consumer Goods & Services (9%); Information Technology (8%); and Financial Services & Real Estate (7%). 
  • Number of Deals: Approximately 69% of private equity respondents made between one and three investments over the last twelve months, and a similar percentage expect to do the same number of deals over the next twelve months.
  • Deal Size: About two-thirds of buyout investments were in the range of $1 million to $10 million of EBITDA. 
  • EBITDA Multiples: Average deal multiples reported for buyout deals for the prior twelve months vary from 5.0 to 8.5+ times EBITDA depending on the size of the company.  Expected returns vary from 20% to 27.5%.
  • Market Issues: Private equity respondents believe domestic economic uncertainty is the most important current and emerging issue facing privately-held businesses.  Other issues include: access to capital; government regulations and taxes; economic uncertainty (international); political uncertainty / elections; competition from foreign trade partners; and inflation.
  • Sellers Going to Market: On the sale side, some of the top reasons cited by sellers for going to market are owner retirement (52% of survey respondents); desire for a recapitalization; desire for new opportunity / business expansion; and owner burnout.
  • Deal Hurdles: According to investment banker survey respondents, the top three reasons for deals not closing were valuation gap (40%), unreasonable seller or buyer demand (21%), and lack of capital to finance the deal (9%).
  • Financing Hurdles: Respondents indicated a general imbalance between companies worthy of financing and capital available for the same, with a reported shortage of capital for those companies with less than $5 million in EBITDA, but a general surplus for companies with $5 million in EBITDA or more.
  • Valuation: When using multiples to determine the value of a business, the most popular methods used by respondents when valuing privately-held businesses were recast (adjusted) EBITDA multiple (59%), revenue  multiple (13%), cash flow multiple (10%) and EBITDA (unadjusted) multiple (10%) approaches.
  • Valuation Gap: Of those transactions that didn’t close due to a valuation gap in pricing, approximately 35% had a valuation gap in pricing between 21% and 30%.
  • Other Deal Considerations:  Approximately 35% of deals closed in the last 12 months involved a Contingent Earn-out. Other common components of closed deals included Seller Financing / Seller Note (reported in 27% deals) and Equity Rollovers (24% of deals).
  • Strategic vs Financial Buyer: Approximately 57% of deals closed over the past 12 months involved strategic buyers, while 43% involved financial buyers.  While a number of respondents didn’t witness any premium paid by strategic buyers, about half saw premiums between 1% and 20%.  For financial buyers, about two-thirds of their recent deal flow were platform investments, with the remaining one third being follow-on investments.
  • Challenging Deal Sourcing:  In order to close a single deal, buyers reported the following median statistics:        
    • review of 73 investment banker pitch decks on target companies,
    • followed by 11 target company meetings;
    • leading to 5 letter of intent (LOI) submissions; and
    • ending in 2 LOI executions (of which, half often did not make it to close).

Disclaimer: The information in this post is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal advice from our firm or the individual author, nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this post should act or refrain from acting on the basis of any information included in, or accessible through, this post without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from a lawyer licensed in the recipient’s state, country or other appropriate licensing jurisdiction.

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