New insights and data on pricing capital in today’s competitive environment from the Pepperdine Private Capital Markets Project show challenges remain for lenders, investors and the private business that depend on them. Lead researcher John Paglia presented at the National Summit for Middle Market Funds.
TEST BANK For Corporate Finance, 13th Edition By Stephen Ross, Randolph Weste...
Pepperdine cost of capital national summit 10 18 2011
1. The Cost of Capital... An Update and New
Details on the Pepperdine Data
National Summit for Middle Market Funds
October 18, 2011
John K. Paglia, Ph.D., CFA, CPA
5. Agenda
• State of Financing for Privately-Held
Businesses
• Insights from Various Segments
– Banks
– Asset Based Lenders
– Mezzanine
– Private Equity
– Investment Bankers
– Limited Partners
• Summary and Conclusion
6. Pepperdine Private Capital Markets Project
• What is cost of capital for SMEs?
• The project launched in 2007; first report in July
2009
• We now survey 12 segments
• Certificate in Private Capital Markets (3-day
curriculum based educational program) offered
again in Malibu, CA November 14-16; Use
“paglia” for discount code to get $300 off
• Reports to be available by mid-November at
http://bschool.pepperdine.edu/privatecapital
7. Pepperdine Private Cost of Capital Line
Expected Returns by Capital Providers on New Investments
Fall 2011
70%
Angel (38% ‐ 47%)
60%
VC (28% ‐ 38%)
50%
40%
PEG (21% ‐ 26%)
30%
Mezz (11% ‐ 16%)
20% ABL (3% ‐ 7%)
Banks (5 ‐ 7%)
10%
0%
1 quartile Median 3 quartile Median Spring 2011
8. How Are Investment Valuation Techniques
Weighted in the Private Markets?
60%
50%
40%
29% 29%
30% 23%
20% 12% 9%
10%
0%
Income
Public
approach Transaction Asset based
company Other
(DCF, NPV, approach approach
approach
IRR)
Average 29% 29% 12% 9% 23%
Angel 14% 21% 8% 5% 51%
VC 15% 40% 16% 5% 23%
PEG 34% 27% 16% 12% 9%
Brokers 30% 34% 5% 13% 18%
Ibanker 34% 34% 15% 11% 6%
Appraisers 50% 20% 13% 10% 8%
9. Which Multiples are Used to
Determine the Value of a Business?
45%
40%
35% 33%
Weight of Use (%)
30%
25%
20%
20% 17%
14%
15%
10% 6% 6% 4%
5%
0%
Recast Net
EBITDA Cash flow Revenue EBIT
EBITDA income Other
multiple multiple multiple multiple
multiple multiple
Average 33% 20% 17% 14% 6% 6% 4%
PEG 25% 30% 18% 10% 6% 6% 3%
Brokers 34% 15% 24% 12% 5% 4% 7%
Ibanker 40% 22% 13% 13% 7% 5% 3%
Appraisers 32% 13% 16% 21% 7% 6% 4%
11. What is the Status of
Privately-Held Businesses
as of Fall 2011?
12. Businesses: Today vs. 6-Months Ago
• Significant increases in prices of labor and
materials
• Increases in unit sales, net income,
opportunities for growth
• Receivables periods lengthening
• General business conditions declining while
significant increase in time worrying about
economy
13. What is the State of Financing?
• Nearly 91% of business owners report having
the enthusiasm to execute growth strategies
• Yet just 49% report having the necessary
financial resources to successfully execute
growth strategies
Source: Pepperdine Private Capital Markets Project Fall 2011 Business Owner Survey, Pepperdine University
14. Top Issues Facing
Privately–Held Businesses
Economic uncertainty (domestic)
2% 2% Access to capital
3%
5%
38% Government regulations and taxes
25%
Inflation
26% Economic uncertainty
(international)
Competition from foreign trade
partners
Other
Source: Pepperdine Private Capital Markets Project Fall 2011 Business Owner Survey, Pepperdine University
15. Business Owners’ Current Sources of
Financing (All sizes)
60%
50% 47%
Frequency (%)
40%
30%
30%
19% 19%
20%
10% 8%
3% 3% 2% 1% 1% 0.3% 0.3%
0%
‐10%
16. Business Owners’ Current Sources of
Financing (>$5 million revenues)
60%
53%
50%
40% 38%
30%
20% 16%
8% 9% 9%
10% 5%
3% 2% 2% 1.4% 0.5%
0%
17. Business Owners’ Estimates of
Cost of Equity (by Revenue Size)
25%
23%
19%
20% 19%
17% 17%
Cost of Equity (%)
15% 15% 15%
15% 15% 14% 14%
15%
13% 13%
10%
11% 11%
5%
0%
Less than $1 million ‐ $5million ‐ $10 million $25 million $50 million $100 ‐ $500 Greater
$1 million $5 million $10 million ‐ $25million ‐ $50 ‐ $100 million than $500
million million million
Mean Median
18. Small Business Financing Success Rates
For Twelve Month Period Ended September 16, 2011
100%
94% 91% 90%
90% 83%
79% 77%
80% 74%
70% 67%
60% 57%
50% 45%
40%
40%
30%
20%
10%
0%
Credit
Avg. Friends Factor Bank Angel ABL Mezz. Hedge PEG VC
card
Less than $5M 51% 78% 63% 47% 44% 41% 38% 25% 23% 23% 20%
$5M ‐ $25M 64% 90% 85% 58% 72% 25% 61% 25% 8% 44% 30%
Greater than $25M 83% 94% 91% 67% 90% 40% 79% 77% 57% 74% 45%
19. Persistence Pays…
Average Number of Capital Providers Contacted for
Successful Financing Outcome
6.0
5.3
5.0
4.8
4.0
4.0 3.6 3.4
3.2
3.0 2.4 2.4 2.3 2.3 2.0
2.0
1.0
0.0
Source: Pepperdine Private Capital Markets Project Fall 2011 Business Owner Survey, Pepperdine University
20. Business Owners’ Expected Time to Exit
(>$5 million revenues)
0.3
25%
0.25 23%
0.2
Percentage (%)
About 30% within 16%
0.15 next five years
11%
0.1
5% 6% 6%
0.05
3% 3%
2%
0
< 1 year 1 year 2 years 3 years 4 years 5 years 5‐10 10‐15 15‐20 >20
years years years years
21. Businesses with Revenues >$5M:
The Next 12 Months
• Significant increases in unit sales along with
product/service pricing and prices of labor and
materials increases
• Increases in net income, opportunities for growth
• Receivables periods lengthening
• No improvement in general business conditions
and further increase in time worrying about
economy
23. Banks: Today vs. 6-Months Ago
• Worsened business conditions and appetite for
risk
• Demand for loans and underwriting standards
flat (despite more due diligence) with slight
increase in credit quality of borrowers
• Increased focus on collateral as backup means
of payment; personal guarantee coverage flat,
but starts to burn off around $5 million in loan
size
• Highly competitive for quality companies; pricing
and loan structures back to pre-crash levels
24. Banks: Loan Sizes Underwritten
60%
51%
50%
40%
40% 36%
29%
30% 25%
24%
20%
10%
0%
Less than $1M $1M ‐ 5M $6M ‐ $10M $11M ‐ 25M $25M ‐ $50M Greater than
$50M
Largest concentrations of loan sizes were between $1 million
and $25 million
25. Banks: Motivations for Loans
Refinancing existing loans or
5% 4% equity
Expansion
10%
49%
11%
Working capital fluctuations
22% Management buy‐out
Finance worsening operating
conditions
Other
Refinancing accounted for nearly 49% of all lending activity
followed by expansion (22%), working capital (11%)
26. Banks: Increased Pressure from Regulators to
Avoid Making Risky Loans?
13% 4%
Agree
82% Neutral
Disagree
Banks declined 63% of cash flow based loans over prior six
months
27. Banks: Senior Leverage Multiples
for Business Services Companies
1st Quartile Median 3rd Quartile
Spring Spring Spring
EBITDA Fall 2011 Fall 2011 Fall 2011
2011 2011 2011
$1M 1.2 1.3 1.2 1.5 1.9 2.0
$5M 2.5 1.4 2.5 2.0 3.0 2.4
$10M 2.5 2.4 2.5 2.5 3.0 3.0
$25M 2.5 2.4 3.0 2.5 3.0 3.0
$50M 2.6 2.5 3.0 3.0 3.0 3.3
$50M 3.1 2.6 3.3 3.0 3.4 3.4
Approximately 1.5X – 2.5X under $25M in EBITDA; 3X and
above greater than $25M
28. Banks: Senior Leverage Multiples
for Manufacturing Companies
1st Quartile Median 3rd Quartile
Spring Spring Spring
EBITDA Fall 2011 Fall 2011 Fall 2011
2011 2011 2011
$1M 1.3 1.5 1.3 1.8 2.0 2.0
$5M 2.1 1.5 2.5 1.8 3.0 2.1
$10M 2.4 2.3 2.5 2.5 3.0 2.8
$25M 2.6 2.4 3.0 2.5 3.0 3.0
$50M 2.5 2.5 3.0 3.0 3.0 3.3
$100M 2.3 2.7 3.0 3.3 3.2 3.5
Approximately 1.8X – 2.5X under $25M in EBITDA; 2.5X and
above greater than $25M
29. Banks: All in Rates on Cash Flow Loans (%)
1st Quartile Median 3rd Quartile
Spring Spring Spring
EBITDA Fall 2011 Fall 2011 Fall 2011
2011 2011 2011
$1 million 5.4 5.5 6.5 7.0 7.1 7.0
$5 million 5.0 5.8 5.5 6.0 6.0 6.0
$10 million 4.5 5.0 5.5 5.5 7.0 5.5
$25 million 3.8 4.8 5.5 5.5 7.2 6.5
$50 million 3.5 3.8 5.0 4.0 7.4 6.5
Rates correspond to loan terms of 60 months (median)
Slight increase in all-in-rates on cash flow loans over the last
6 months, except for large companies
30. Banks: Financial Evaluation Metrics (Medians)
Average Importance
Approval Limits
Borrower Score (0‐4)
Spring Fall Spring Fall Spring Fall
2011 2011 2011 2011 2011 2011
Current ratio 1.4 1.4 1.3 1.1 1.7 1.6
Total debt service coverage
1.3 1.3 1.3 1.2 3.7 3.5
ratio
Total debt to cash flow 2.5 2.8 2.8 4.0 3.2 3.0
Debt to net worth 2.0 2.0 2.4 3.0 2.5 2.2
Approval thresholds in Fall 2011 are lower than in Spring 2011
but average borrower characteristics are relatively constant
31. Banks: The Next 12 Months
• Sharp increase in demand for loans, lending
capacity of banks and SBA lending
• Underwriting standards and credit quality of
borrowers relatively flat
• Further increases (slight) in senior/total
leverage multiples
• Relatively flat business conditions
• Increasing due diligence efforts and further
pricing compression
33. ABLs: Today vs. 6-Months Ago
• Increased demand for loans
• Slight increase in standard advance rates on
collateral
• Compressed loan fees and spreads
• Increase in loans outstanding
• Slight decline in business conditions
34. ABLs: Loan Sizes Underwritten
60%
50% 48%
40%
30% 28% 28%
24%
20% 16% 16% 16%
10% 8%
0%
Less than $1M ‐ 5M $5M ‐ $10M ‐ $25M ‐ $50M ‐ $100M ‐ Greater
$1M $10M 25M $50M $100M $500M than
$500M
Largest concentrations of loan sizes were between $1 and $5
million (48%)
35. ABLs: Motivations
Refinancing
5%
13% Finance worsening operations
13% conditions
55%
Fluctuating working capital
17%
Expansion
Other
Refinancing accounted for nearly 55% of all lending activity
followed by worsening operations conditions (13%) and
working capital (13%)
36. ABLs: Advance Rates
Typical Loan (Median %) Upper Limit (Median %)
Spring
Fall 2011 Spring 2011 Fall 2011
2011
Marketable securities 80 90 90 90
Accounts Receivable 80 85 85 85
Inventory ‐ Low quality 25 25 40 30
Inventory ‐ Intermediate
40 45 50 50
quality
Inventory ‐ High quality 55 60 60 60
Equipment 60 75 80 75
Real Estate 60 65 70 70
Land 50 40 50 42
On average, advance rates are slightly higher than 6
months ago
37. ABLs: Collateral Valuation Standards
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Purchase price 10%
6%
Depreciated Value (Book)
Face value 35%
Fair Market Value 87%
Forced Liquidation
33%
63%
Orderly Liquidation
44%
Other
Equipment Real estate Accounts Receivable Inventory
38. ABLs: All in Rates (%)
Type and Size 1st Quartile Median 3rd Quartile
Spring Fall Spring Fall Spring Fall
2011 2011 2011 2011 2011 2011
WORKING CAPITAL
$5M 5.0 6.8 7.0 9.3 11.0 12.0
$25M 3.0 3.8 3.4 4.9 4.4 10.5
$50M 3.0 2.8 3.3 3.0 4.0 3.3
$100M 2.6 2.5 3.0 2.8 3.4 3.1
EQUIPMENT
$5M 5.3 5.5 7.3 6.5 8.9 6.5
$25M 3.9 3.4 5.8 3.6 7.1 3.9
$50M 3.5 2.6 4.0 2.8 5.6 3.1
$100M 3.4 2.5 4.0 2.5 4.6 2.5
All-in-rates are lower than 6 months ago except small
size lending with working capital as a collateral
39. ABLs: Financial Evaluation Metrics (Medians)
Average Approval Importance
Borrower Limits Score (0‐4)
Spring Fall Spring Fall Spring Fall
2011 2011 2011 2011 2011 2011
Current ratio 1.0 1.7 1.0 1.2 1.1 0.9
Total debt service
1.2 1.1 1.0 1.0 2.6 2.4
coverage ratio
Total debt to cash flow 3.5 3.0 3.8 4.0 2.4 2.3
Debt to net worth 2.1 2.8 2.5 2.7 2.1 1.7
Revenue growth rate 1.1% 5.0% 1.0% 5.0% 1.5 1.8
40. ABLs: The Next 12 Months
• Sharp increase in demand for loans and
loans outstanding
• Underwriting standards slightly more
stringent but credit quality of borrowers will
continue to improve
• See business conditions generally flat
• Relatively flat pricing
42. Mezzanine: Today vs. 6-Months Ago
• Demand for mezzanine financing up
• Increased credit quality of borrowers
• Warrant coverage down, deal and leverage
multiples up, expected returns down with more
competition
• Time to exit investments slightly longer
• Underwriting standards relatively flat
• Significant decrease in general business
conditions
43. Mezzanine: Loan Sizes Underwritten
70%
60% 58%
50%
39% 37%
40%
30%
20% 18%
10%
10% 6% 5%
0%
Less than $1M ‐ 5M $5M ‐$10M$10M ‐25M $25M ‐ $50M ‐ $100M ‐
$1M $50M $100M $500M
Largest concentrations of loan sizes were between $5 and $10
million (58%)
44. Mezzanine: Loan Motivations
Acquisition loan
5% 2%
Management buyout
15% 29%
Refinancing
15%
28% Financing growth
Working capital fluctuations
Finance worsening operations
conditions
Acquisition loan investments accounted for 29% of activity,
followed by MBO (28%), refinancing (15%) and growth (15%)
45. Mezzanine: To Make One Investment…
70
60
60
50
40
40
30
20
15
10
10 6 8
2 2
0
Plans Reviewed Meetings Proposal Letters LOI
Median Average
46. Mezzanine: Interest Rates (%)
Sponsor Transactions
1st Quartile (%) Median (%) 3rd Quartile (%)
Spring Spring Spring
EBITDA Size Fall 2011 Fall 2011 Fall 2011
2011 2011 2011
$1M 12 12 13 12 14 13
$5M 12 12 13 12 13 13
$10M 12 11 13 12 13 12
$25M 12 10 12 11 12 12
$50M 10 11 12
$100M 7 11 12
Mezzanine interest rates for sponsor transactions are
lower than 6 months ago
47. Mezzanine: PIK (%)
Sponsor Transactions
1st Quartile (%) Median (%) 3rd Quartile (%)
Spring Spring Spring
EBITDA Size Fall 2011 Fall 2011 Fall 2011
2011 2011 2011
$1M 3 1 4 1 4 2
$5M 2 1 3 3 4 3
$25M 3 3 3 4 3 4
$50M 4 4 4
48. Mezzanine: Total Expected Returns (%)
Sponsor Transactions
1st Quartile (%) Median (%) 3rd Quartile (%)
Spring Spring Spring
EBITDA Size Fall 2011 Fall 2011 Fall 2011
2011 2011 2011
$1M 18 16 20 20 22 21
$5M 18 19 20 20 22 26
$10M 17 15 19 18 20 20
$25M 18 12 19 16 19 20
$50M 13 14 15
$100M 7 13 16
Mezzanine total returns decreased for $10 million and $25
million loans in the last 6 months
49. Mezzanine: Interest Rates (%)
Non-Sponsor Transactions
1st Quartile (%) Median (%) 3rd Quartile (%)
Spring Spring Spring
Fall 2011 Fall 2011 Fall 2011
2011 2011 2011
$1M 13 10 14 12 14 14
$5M 12 12 14 12 14 14
$10M 12 12 12 12 13 14
$25M 12 10 12 12 13 13
Mezzanine interest rates for non-sponsor transactions are
slightly lower than 6 months ago
50. Mezzanine: PIK (%)
Non-Sponsor Transactions
1st Quartile (%) Median (%) 3rd Quartile (%)
Spring Spring Spring
Fall 2011 Fall 2011 Fall 2011
2011 2011 2011
$1M 2 2 2 2 2 2
$5M 1 2 2 2 2 2
$25M 3 2 3 3 3 3
$50M 2 3 3
Relatively constant percentages
51. Mezzanine: Total Expected Returns (%)
Non-Sponsor Transactions
1st Quartile (%) Median (%) 3rd Quartile (%)
Spring Spring Spring
Fall 2011 Fall 2011 Fall 2011
2011 2011 2011
$1M 23 17 24 19 25 20
$5M 22 20 22 19 24 25
$10M 20 16 20 18 21 25
$25M 18 15 18 17 19 21
Mezzanine total returns decreased for almost all loan sizes
in the last 6 months
52. Mezzanine: Total Leverage Ratios
1st Quartile (%) Median (%) 3rd Quartile (%)
Spring Spring Spring Fall
Fall 2011 Fall 2011
2011 2011 2011 2011
$1M 2.9 3.0 3.5 3.5 4.1 3.5
$5M 3.5 3.0 3.5 3.5 4.0 4.0
$10M 3.5 3.5 4.0 4.0 4.0 4.5
$25M 4.4 4.0 4.8 4.5 5.0 5.0
$50M 4.0 4.8 5.0
$100M 5.0 5.0 5.5
Represents additional 1 – 2 turns of EBITDA (after senior),
increasing with size. Relatively constant when compared to
Spring 2011.
53. Mezzanine: Time to Exit (Months)
1st Quartile Median 3rd Quartile
Spring Fall Spring Fall Spring Fall
2011 2011 2011 2011 2011 2011
$1M 36 60 48 60 63 60
$5M 48 60 54 60 60 60
$10M 48 60 60 66 60 72
$25M 33 60 36 60 42 72
$50M 60 72 78
$100M 72 78 84
Looking to exit in 5-7 years
Exit times are longer than 6 months ago
54. Mezzanine: Financial Evaluation Metrics
(Medians)
Average Approval Importance
Borrower Limits Score (0‐4)
Spring Fall Spring Fall Spring Fall
2011 2011 2011 2011 2011 2011
Senior debt service
1.6 1.5 1.3 1.2 3.3 2.4
coverage ratio
Total debt service
1.3 1.4 1.2 1.2 2.7 3.3
coverage ratio
Senior debt to cash flow 2.5 2.5 3.0 3.0 3.4 2.9
Total debt to cash flow 3.5 4.0 4.0 4.0 3.4 3.6
55. Mezzanine Investments: Transactions in
Next 12 Months
0 to 2
11% 7% 3 to 5
13%
39%
6 to 10
32%
11 to 15
more than 15
Largest concentration of responses indicates plan for 3 – 5
transactions in next 12 months (39%); 32% are planning
between 6 and 10
56. Mezzanine Investments: Segments Targeted
in Next 12 Months
Business Services
2% 3%
Manufacturing
8% 22%
8% Health Care
10% Retail and Consumer Services
21%
12% Wholesale & Distribution
14% Information Technology
Basic Materials & Energy
Financial Services
Other
Business services (22%), manufacturing (21%), and
healthcare (14%) look to be areas targeted for investment
57. Mezzanine: A View to the Next 12 Months
• Increasing demand for mezzanine capital, but
flat leverage multiples
• Slight increase in underwriting standards
• Relatively flat loan fees, PIK, and warrant
coverage
• Significant decrease in general business
conditions
• Increasing size of mezzanine industry with
additional competition from business
development companies (BDCs) and SBIC
funds
59. Private Equity: Today versus 6 Months Ago
• Increased demand for private equity and
increases in quality of companies
• Increased deal multiples, exit times longer
• Increased amount of non-control
investments
• Decrease in expected returns on new
investments and lower appetite for risk
• Worsened general business conditions
60. Private Equity: Investment Activity
in Last Six Months
4% 4% 0
7%
26% 1
11%
2
17% 3
31%
4
5
more than 5
Nearly 74% of respondents reported making a deal in the last
6 months; approximately 26% reported no transactions
61. Private Equity: Investment Checks Written
40%
35%
35% 33% 33%
30%
30%
25%
20% 18%
16%
15%
10% 8%
5% 3%
0%
Less than $1‐5 $5‐$10 $10‐25 $25‐$50 $50‐$100 $100‐$500 Greater
$1 million million million million million million million than $500
million
The largest concentration of checks written was in the $10 -
$25 million range (35%) followed by $25 - $50 million (33%)
and $5 - $10 million (33%)
62. Private Equity: To Make One Investment…
160
142
140
120
100
100
80
60
40
22
20 15
5 9
2 2
0
Plans Reviewed Meetings Proposal Letters LOI
Median Average
63. Private Equity Balance of Capital with
Businesses Worthy of Financing:
Surplus or Shortage?
1.2
0.7 0.7
0.7 0.5 0.6
Relative 0.3
Score (‐2 to 2)
0.2 Shortage 0.1
‐0.3
‐0.6
‐0.8
‐0.9
‐1.3
$1M $5M $10M $15M $25M $50M $100M > $100M
EBITDA EBITDA EBITDA EBITDA EBITDA EBITDA EBITDA EBITDA
Score ‐0.9 ‐0.6 0.1 0.3 0.5 0.6 0.7 0.7
65. Private Equity: Deal Multiples (of EBITDA)
EBITDA 1st Quartile Median 3rd Quartile
Spring Spring Spring
Fall 2011 Fall 2011 Fall 2011
2011 2011 2011
$1M 3.9 3.0 4.0 4.0 5.3 5.5
$5M 4.5 3.5 5.0 4.5 5.7 6.0
$10M 5.0 4.5 6.0 5.5 7.0 7.0
$25M 5.5 5.0 6.0 6.0 7.8 7.5
$50M 7.5 5.0 7.5 6.5 8.0 8.5
Median deal multiples starting to exhibit weakness
66. Private Equity: Equity Contributions (%)
EBITDA 1st Quartile (%) Median (%) 3rd Quartile (%)
Spring Spring Spring
Fall 2011 Fall 2011 Fall 2011
2011 2011 2011
$1M 39 45 60 60 83 95
$5M 40 45 60 55 70 85
$10M 50 38 58 50 62 55
$25M 25 35 48 45 60 53
$50M 21 25 33 35 40 35
$100M 10 35 20 35 23 55
Median equity contributions reported range from a high of 60%
for smaller transactions to 35% for larger companies
67. Private Equity: Expected Returns (%)
EBITDA 1st Quartile (%) Median (%) 3rd Quartile (%)
Spring Spring Spring
Fall 2011 Fall 2011 Fall 2011
2011 2011 2011
$1M 25 25 30 30 35 38
$5M 25 23 30 25 30 35
$10M 25 23 30 25 31 30
$25M 25 23 28 25 30 30
$50M 22 23 25 25 30 30
$100M 23 25 27
$500M 21 23 27
Expected gross annual returns on new investment range from a
median of 25% for most large transactions to 30% for smaller
ones
Expected returns are significantly lower than 6 months ago
68. Private Equity: Exit Times (Months)
EBITDA 1st Quartile Median 3rd Quartile
Spring Spring Spring
Fall 2011 Fall 2011 Fall 2011
2011 2011 2011
$1M 48 48 60 60 60 60
$5M 48 48 60 60 60 60
$10M 36 46 48 60 48 60
$25M 37 40 48 48 60 51
$50M 48 30 48 48 60 48
$100M 48 48 48 48 48 60
$500M 48 48 60
Expected exit times range from 48 months for larger
transactions to 60 months for smaller ones
69. Private Equity Investing: Number of
Transactions in Next 12 Months
0
2%
5% 1
6% 8% 9%
2
9%
30%
3
30% 4
5
6
more than 6
60% are looking to make 2 – 3 investments in the next year
70. Private Equity Investing: Segments Targeted
in Next 12 Months
Manufacturing
6% Business Services
13% 19%
6% Health Care
7% 16% Retail & Consumer Services
9% Basic Materials & Energy
12% 12%
Wholesale & Distribution
Financial Services
Information Technology
Other
Manufacturing (19%), business services (16%), healthcare
(12%), and retail & consumer services (12%) appear to be the
targets of 59% of investments
71. Private Equity: A 12-Month View
• Increasing demand for private equity and
quality of companies seeking investment
• Increasing amount of non-control investments
• Deal multiples increasing further
• Generally flat to slightly lower expected
returns on new investments
• Worsening general business conditions and
lower appetite for risk
73. Investment Bankers: Today vs.
6-Months Ago
• Deal flow up slightly
• Relatively flat leverage and deal multiples
• Extended time / increased difficulty to sell
business
• Increased presence of strategic buyers
• Increased margin pressure on companies
• Worsened business conditions
74. Investment Banks: Business Sales
Transactions in Last 6 Months
0
1
6% 6%3% 9% 25%
2
7% 3
20% 24% 4
5
6
more than 6
75% report making at least one deal in last 6 months; 51% made
between 1 – 3 while 25% didn’t make any
75. Investment Banks: Time to Transact
Businesses in Last 6 Months
4%
2 ‐ 4 months
9% 7%
22% 4 ‐ 6 months
16%
6 ‐ 8 months
13% 8 ‐ 10 months
29%
10 ‐ 12 months
12 ‐ 18 months
more than 18 months
The largest concentration of transactions closed in 6-8 months
(29%); another 22% closed in 4-6 months
76. Investment Bankers: Percentage
33.5%
of Deals with …
33.0% 32.8%
32.5%
32.0%
31.9%
Frequency (%)
31.5%
31.1%
31.0%
30.7%
30.5%
30.0%
29.5%
29.0%
Seller Financing / Contingent Adjusted amount Lowered multiple
Seller Note earnout of equity sold of EBITDA
77. Investment Banks: Are Strategics
Outbidding Financial Buyers?
No
3% 2% 13% 19% Yes, 0‐10% more
13%
23% Yes, 11‐20% more
Yes, 21‐30% more
28%
Yes, 31‐40% more
Yes, 41‐50% more
Yes, >50% more
Roughly 19% report that strategic buyers didn’t pay premiums
relative to financials’ offers; 23% report premiums less than
10% and another 28% report premiums between 11-20%
78. Investment Banks: 43% of Engagements
Expired Without Transaction! Why?
Valuation gap in pricing
Economic uncertainty
8% 6% 6% 2%
29% Unreasonable seller or buyer demand
14% Lack of capital to finance
18% No market for business
17%
Other
Insufficient cash flow
Seller misrepresentations
37% report valuation gap of less than 20%; 39% report
21 – 30% valuation gap
81. Investment Banks: Next 12-Months
Transactions Forecast
2%
0
7% 7% 13% 1
12%
2
16% 23% 3
20% 4
5
6
more than 6
Almost half (48%) report an expectation to transact between
3 and 5 businesses during the next 12 months
82. Investment Banks: The Next 12 Months
• See deal flow up sharply
• Relatively flat leverage and deal multiples
• Extended time / slightly increased difficulty to
sell business
• Increased presence of strategic buyers
• Increased margin pressure on companies
• Worsening business conditions
84. What about the Limited Partners (LPs)?
• Compared to six months ago...
– Allocations to VC, Mezz, Hedge, Secondaries
down slightly
– Allocation to PE up slightly
– Direct investments are up
– Business conditions down but expected
returns on new investment up
85. Limited Partners: Strategy with Best Risk
and Return Trade-off?
25%
20%
20% 19%
15% 13%
11%
10%
7% 7% 7%
6% 6%
5% 4%
0%
86. Industry Segments with Best Risk and
Return Tradeoffs
0.6
48%
Frequency of Response (%)
0.5
0.4 36% 34%
30%
0.3
24%
0.2
12% 10% 10%
0.1 8%
0
86
87. Limited Partners’ Return Expectations on
New Investments (%)
25.0
20 20 20
20.0
18 18
Gross expected returns (%)
15 15 15 15
15.0
13
10.0
5.0
0.0
PE ‐ PE ‐ PE ‐ Second Real Fund of
VC Directs Mezz Hedge
Buyout Grow Distr. . Estate Funds
Median 20.0 20.0 20.0 18.0 18.0 15.0 15.0 15.0 15.0 12.5
Mean 21.0 20.4 19.3 19.4 17.4 17.4 13.1 13.1 14.3 12.5
88. Importance of Factors When Raising Funds
5
4.5 4.4
4.0
4
Importance Factor (1‐5)
3.5 3.5 3.3 3.2
3
2
1
0
General Specific Hist. Perf. all Returned Residual Gut feel / Specific
partner strategy Funds capital from value of Instinct location
most recent most recent
fund (DPI) fund (RVPI)
89. LPs: The Next 12 Months
• Increasing allocations to alternative assets
• See best domestic opportunities in
California, Texas, New England states
• Allocations to various strategies relatively
flat, but direct investments up
• Business conditions and expected returns
up slightly
90. Conclusions
• Deteriorated business conditions across all
segments surveyed; no significant improvements
expected in next 12 months
• Starting to see early signs of leverage / valuation
stagnation (and decline), accompanied with
higher pricing, particularly for smaller businesses
• Extremely competitive conditions for quality large
companies
• Capital intensive businesses appear to be eligible
for more favorable loan pricing (ABL) and are
likely to continue with extended economic
weakness
91. Conclusions (Cont’d)
• Expected returns on new investments declining
with longer exit times; more competition
• Opportunities appear to exist for investments in
smaller businesses (< $10M EBITDA); debt
more available than it was six months ago in
$5M EBITDA segment
• See increased opportunities for working capital
funding with receivables extending, inventories
building, and margins compressing
• Expected continued demand for all capital types
• Invest cautiously
92. A True Win-Win…
Top Policy Actions for Job Growth in 2012
According to 10,644 Small Business Owners
Increased access to capital
3.8%
12.0%
7.9% 34.8% Tax incentives
Regulatory reform
18.3%
23.2% Increased competitiveness with
foreign trade partners
Education reform
Other
Source: Pepperdine Private Capital Markets Project Fall 2011 Business Owner Survey, Pepperdine University
93. Thank You!
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