The State of the Private Capital Markets

Private Capital Markets LaunchPadJune 10, 2011John K. Paglia, Ph.D., CFA, CPA

Associate Professor of FinanceSenior Researcher, Pepperdine Private Capital

Markets Project

• What is cost of capital for privately-held businesses?

• The project launched in 2007; first report in July 2009

• We now survey 12 segments semi-annually

• Survey asks about firm profile, behavior, returns, view of next 12 months

• Next report to be released Monday

• Certificate in Private Capital Markets

Pepperdine Private Capital Markets Project

What is the Status of Privately-Held Businesses

as of Spring 2011?

What are Owners Focusing on Today?

• Nearly 95% of business owners report having the enthusiasm to execute growth strategies

• Yet just 53% report having the necessary financial resources to successfully execute growth strategies

State of Financing

• How much senior leverage is available for transactions?

• How much junior leverage is available and what are the total debt thresholds?

• How much equity is available for growth capital and transactions?

Capital Access Drives Valuations and Deal Flow in the Middle Markets

Median Deal Multiples by Financial BuyersInvestment Banker Survey (Spring 2011)

Industry$1M

EBITDA

$5M

EBITDA

$10M

EBITDA

$15M

EBITDA

$25M

EBITDA

$50M

EBITDA

$100M

EBITDA

Service 4.0 5.0 6.0 7.0 7.0 8.0 12.0

Mfg. 4.0 5.0 6.0 5.3 6.0 7.0 10.0

Retail 3.5 5.0 6.0 7.0 6.0 7.5 8.5

Wholesale 4.8 5.3 3.3 4.0 6.5 7.0 8.0

Distribution 4.3 5.3 5.0 4.5 5.3 6.5 6.0

Oil and Gas 4.5 4.0 4.0 5.0 6.0 7.0 NA

Restaurant 3.0 3.0 3.5 4.0 6.0 6.0 NA

Healthcare 5.0 6.5 6.8 6.0 6.0 7.0 7.0

Technology 5.0 7.0 8.0 9.0 8.0 10.5 9.0

Media / Ent. 5.5 5.5 4.0 7.0 7.0 8.0 7.5

Average 4.4 5.2 5.3 5.9 6.4 7.5 8.5

Business Transfer Intentions (Spring 2011)

Business Transfer Timing (Spring 2011)

Overall Impressions of Capital SourcesCapital Source

Very unfavorable Unfavorable

Slightly Unfavorable Neutral

Slightly Favorable Favorable

Very favorable

Score(-3 to 3)

Bank loan

6% 5% 6% 11% 15% 34% 22% 1.48

Asset based lender

4% 6% 9% 21% 20% 29% 11% 1.08

Private equity fund

6% 12% 11% 24% 20% 20% 7% 0.51

Angel investor

9% 13% 14% 23% 21% 14% 5% 0.12

Venture capital fund

10% 17% 14% 22% 19% 15% 2% -0.07

Mezz Fund

9% 14% 14% 35% 16% 11% 2% -0.12

Friends and family

19% 18% 11% 18% 10% 15% 9% -0.22

Factor 15% 19% 13% 29% 11% 9% 4% -0.48

Capital Providers

• 37% of activity from refinancing; 17% acquisitions; 12% growth financing

• 60% of applications declined, 36% lack high-quality earnings/cash flow

• Demand for loans up, due diligence efforts increased significantly

• Leverage increased slightly

What’s Happening in Banks

• Personal guarantees and collateral requirements mandatory under $15 million

• Regulatory pressure to avoid risky loans increased, 76% report feeling increased pressure

• 60% indicate that increased pressure led to declining loans that otherwise would have been made

What’s Happening in Banks (Cont’d)

• 26% of investments in next 12 months in business services, 25% in manufacturing, 14% in wholesale and distribution

• Demand for investment up considerably along with leverage and deal multiples

• Confidence and conditions improving

• Warrant coverage and expected returns down slightly

What’s Happening in Mezz

• 25% of investments in next 12 months in manufacturing, 14% in business services, 14% healthcare

• Demand for investment up considerably along with leverage and deal multiples

• Confidence and conditions improving

What’s Happening in PE

• Power of LPs increasing! 30% say beneficial; 38% say detrimental

• 56% now looking at larger/smaller investments to deploy capital

• Making more minority investments; 60% indicate no change in expected returns

What’s Happening in PE (cont’d)

Insights from Investment Bankers

• Deal flow has increased slightly

• Leverage multiples have improved slightly, as have deal multiples, particularly for later-stage companies

• Due diligence efforts by banks and buyers have increased

Compared to Six Months Ago

40% of Business Sale Engagements Expired Without a Transaction

Valuation Gaps for Non-Transacted Engagements

Difficulty Securing Senior Debt?

Very

difficultDifficult

Somewhat

DifficultNeutral

Somewhat

EasyEasy Very Easy

%

Difficult

$1M EBITDA 41.3% 27.3% 19.8% 8.3% 2.5% 0.0% 0.8%88.4%

$5M EBITDA 12.7% 14.4% 33.9% 23.7% 10.2% 1.7% 3.4%61.0%

$10M EBITDA 6.6% 10.5% 15.8% 25.0% 27.6% 11.8% 2.6%32.9%

$15M EBITDA 5.8% 5.8% 19.2% 19.2% 28.8% 19.2% 1.9%30.8%

$25M EBITDA 6.5% 4.3% 17.4% 21.7% 19.6% 21.7% 8.7%28.2%

$50M EBITDA 11.4% 5.7% 5.7% 20.0% 28.6% 14.3% 14.3%22.8%

$100M+ EBITDA 12.9% 6.5% 3.2% 25.8% 22.6% 12.9% 16.1%22.6%

Balance of Capital with Opportunities Companies worthy of

financing GREATLY

exceed capital available

Companies

worthy of

financing exceed

capital available

General balance

between companies

worthy of financing

and capital available

Capital available

exceeds companies

worthy of

financing

Capital available

GREATLY exceeds

companies worthy

of financing

Score

$1M EBITDA 28.6% 37.1% 20.0% 11.4% 2.9% -0.8

$5M EBITDA 13.2% 30.9% 32.4% 17.6% 5.9% -0.3

$10M EBITDA 5.7% 17.0% 39.6% 24.5% 13.2% 0.2

$15M EBITDA 4.9% 22.0% 29.3% 31.7% 12.2% 0.2

$25M EBITDA 6.3% 15.6% 31.3% 18.8% 28.1% 0.5

$50M EBITDA 13.8% 10.3% 13.8% 31.0% 31.0% 0.6

$100M EBITDA 18.5% 11.1% 14.8% 22.2% 33.3% 0.4

> $100M EBITDA 14.8% 11.1% 14.8% 11.1% 48.1% 0.7

Top Issues Facing Privately Held Businesses (Today versus Emerging)

Today

Emerging

• Business owners are more optimistic, back to focusing on expansion, and looking for exit opportunities

• Capital availability is robust for larger companies, still a concern for smaller ones

• Deal market active for larger companies, improving for smaller ones

M&A OutlookThe Road Ahead

John K. Paglia, Ph.D., CFA, CPA

Associate Professor of Finance

Senior Researcher, Pepperdine Private Capital Markets Project

bschool.pepperdine.edu/privatecapital

john.paglia@pepperdine.edu

Thank You!