Our quarterly valuation review explores recent valuation trends in the public and private markets, directed to small and middle market business owners and the professionals and financial institutions that serve them. The review is designed to provide realistic guidance on the question “What’s it Worth?,” keeping in mind that proper preparation for real world transactions requires analysis of specific situations based on up-to-date data.

Executive Summary

U.S. private equity activity declined during the first quarter of 2016, but the lower middle market (LMM) experienced a spike in deal value and volume, leading to the most capital invested in the LMM since early 2008. Private equity firms continued to chase smaller deals: almost 60% of all private equity buyouts were add-ons and fundraising trends indicated a continued focus on smaller, focused funds. Transaction multiples remained elevated and buyers continued to utilize significant levels of debt to fund acquisitions. At PW&Co, we saw a large uptick in businesses looking to grow; raising growth capital or expanding through acquisition – a positive sign for the Alabama economy.

Money continued to flow into early stage investments, but venture capital (VC) investors have pulled back and begun to decelerate venture activity. Despite a decline in activity, capital invested remained robust and the VC industry is on pace for a very strong year. The figures below summarize the industry verticals with the most VC activity in 2016. The majority of VC activity has focused on SaaS (software-as-a-service) and mobile applications, while early-stage oncology and life science businesses achieved the largest valuation jumps from new financing rounds (pre-money to post-money valuation) during the quarter.

Valuation Multiples in M&A Deals

Multiples of middle-market companies (defined here as companies with transaction values between $10M and $250M) continued to remain strong in 2016; however, multiples in the largest size categories dipped slightly while the lower-middle market businesses continued to surge, as shown in Figure C below. As shown in the figure below, middle-market companies sold to financial buyers for an average of 6.7x trailing 12-month EBITDA during 2016, unchanged from 2015.

As shown in Figure D below, value is driven by a variety of factors, including existing ownership (individual/family or institutional), transaction purpose (platform or add-on), financial characteristics, and continuation of management post-closing. In almost all of these categories, private equity buyers have paid a size premium for larger businesses over comparable smaller ones. At the lower end of the middle market with enterprise value less than $25 million, sellers appear to be getting less of a bump for relative value factors compared to larger deals.

Publicly Traded Valuation Multiples

Private transaction multiples are the most direct evidence of valuations in the private markets. However, public markets also provide an important view of valuation metrics and show how sophisticated investors currently view and quantify risk in a given company, industry, or geography. The current P/E ratio (current price divided by latest 12-month earnings) of the S&P 500 index increased to 24.0 at the end of March 2016, up from 21.4 one year prior. The Shiller P/E ratio (current price divided by average earnings over 10 years) decreased to 26.0 from 26.8 over the same time period.

Debt Markets

Debt utilization continued to increase in early 2016, helping private equity firms fund expensive transactions at current deal prices. Total leverage for add-on transactions averaged 5.1x EBITDA (compared to 3.7x EBITDA for platform acquisitions), as acquirers used their existing company’s financials to obtain increased levels of debt. Senior debt pricing averaged 4.6% (4.0% spread over 90-day LIBOR) in Q1 2016, a decrease from 2015 levels, and subordinated debt interest rates averaged 11.3% (14.6% all-in, including PIK and warrants) in Q1 2016. The figure below summarizes the change in leverage ratios over the past five years.

Conclusion

Business owners often have a significant amount of their net worth tied to their own businesses. When evaluating business options (expansion opportunity, company sale, ESOP feasibility, succession plan, etc.) a business valuation is often a good place to start. At PW&Co, our expertise in valuation allows us to advise clients on valuation issues in connection with the sale of companies and informs our advice on the process by which they are sold. When selling an entire company, we advise clients to look for synergistic and industry buyers who can realize the greatest benefits from the acquisition, and thus pay the highest price for the company. Regardless of market conditions, successful liquidity events take preparation and time. We encourage our clients who are considering the sale of their business, raising debt or equity capital for growth, evaluating succession plan options, or contemplating how to put their capital to work most effectively to contact us to discuss how to prepare in advance to achieve the best possible outcome.

Information in the above report should not be reproduced in any manner or used in work product without written permission from the data source or from PW&Co.
[1] Figure A. Source: Pitchbook.com, accessed July 12, 2016.
[2] Figure B. Source: Pitchbook.com, accessed July 12, 2016.
[3] Figure C. Source: GF Data®, M&A Report, May 2016.
[4] Figure D. Source: GF Data®, M&A Report, May 2016.
[5] Figure E. Source: Multpl.com, accessed July 1, 2016.
[6] Source: GF Data®, Leverage Report, May 2016.
[7] Figure F. Source: GF Data®, Leverage Report, May 2016.

Valuation Practice

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Michael Stone, CFA, AM

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