Last month, members of the Porter White & Company (PW&Co) team attended a professional conference with over 1,000 middle-market private equity professionals and other capital providers. The story we have heard for the past few years continued – competition to invest capital and close deals has continued to drive up valuation multiples. With three members of PW&Co at our booth, we still often had a line of people waiting to speak to us, indicating the eagerness of private equity firms to deploy capital. Based on the conversations that took place, we identified the following key takeaways:
- Larger companies ($10+ million EBITDA) are garnering multiples of over 10x EBITDA and smaller deals have been reaching the 7x-8x EBITDA range.
- Acquisitions of companies with less than $3M EBITDA have historically had a lot less competition from private equity groups, but increased competition and elevated deal multiples have pushed these groups to pursue smaller deals.
- There is a buyer for every type of business. The number of formalized family offices continues to grow in the private equity marketplace.
We’ve worked with many companies in the lower middle-market (less than $5M of EBITDA), and while these types of companies still tend to be more attractive to smaller, local private equity firms and family offices, larger national firms have been forced to seek out smaller deals in order to deploy capital.
People often ask me, “What’s driving elevated transaction multiples?” Fundamentally, it should be a result of changes to one of two main factors: decreased required return (risk) and increased growth. As the overall economy improves, most businesses are seeing an uptick in growth. Low interest rates and competition from banks have allowed buyers to lower their cost of capital and leverage the acquired business. While these factors explain some of the multiple changes, many in the industry believe that other firms in the industry are grossly overpaying for businesses. Anecdotally, one private equity firm partner mentioned that junior partners who are aggressively trying to close one deal may overpay for a steady business (10-11x EBITDA) in order to deploy capital, earn a decent return, and keep their job. It’s also hard to collect a management fee or raise a new $500 million private equity fund if you haven’t been able to invest much of the prior fund. This is reflected in the unprecedented prices that private equity firms are currently willing to pay for businesses.
Another important takeaway from the conference is that there is a buyer for every type of business, as long as it is well run. Most want control, but not all aim to operate the business. Most want growing, profitable businesses, but some look for distressed businesses. Some of the risks facing small investors in private businesses (customer concentration, key manager risk, distressed financials, etc.) can be diversified away (or at least significantly reduced) by industry strategic investors and larger sophisticated private equity buyers who own (or plan to acquire) other businesses in the industry.
At PW&Co, we help business owners navigate the universe of potential buyers, identifying the right buyer for each company. With the current overabundance of private capital and limited number of quality middle-market businesses for sale, sellers are positioned to have very successful exits in 2016. If you know of a business that needs advice on how to execute an advantageous sale, we can help.