2015 was a sellers’ market with transaction multiples increasing. According to Vancouver investors, “7x is the new 6x” in the lower mid-market. It was also a strong year for private equity in Canada with a total of 399 deals – worth $22.8B – completed according to the CVCA. Of these, 239 or 60% were in provinces served by First West Capital.
The good news for business owners looking to exit is that it is not just the larger deals that are attracting higher multiples. Multiples soared at the lower end of the market as well. But why? There are a number of contributing factors:
- Leveraged buyouts are on the rise as interest rates remain low so companies can afford more debt.
- Traditional banks are also looking to increase their yield by offering an increasing number of alternatives to traditional loans to smaller companies including cash flow lending and higher lending ratios on tangible assets.
- Competition for providing financing to strong companies is increasing amongst traditional lenders and so many are taking a longer view of the relationship, even if the immediate request does not fit traditional lending guidelines.
- Although somewhat overshadowed by depressed oil prices, the weak loonie has made investments by US firms into Canada very attractive.
- Accumulation of “dry powder” or un-deployed funds – in the US alone, there is over USD$550B waiting to be invested. During the recession, many private equity funds raised capital but were unable to deploy it. As a result, there is a lot of liquidity in the private equity market.
- It’s not only the private equity firms that have deep pockets – strategic buyers also have strong balance sheets and the operational ability to extract maximum value from acquisitions. Strategic buyers may pay more for a company for reasons other than financial gain, it might use the target company to enter a new market, integrate part of the supply chain, or eliminate competition. Strategic buyers are adding to the froth created by private equity.
- With the high multiples, investors need to work extra hard to achieve an acceptable return on their investment. As such, they increasingly seek scale, efficiencies, and vertical integration. Bolt-on acquisitions are therefore attractive to private equity investors seeking synergies within their existing portfolio.
- The supply of strong companies with professional management teams that are ready for sale and straightforward to transition away from the current owners is limited. The relative oversupply of capital relative to the number of companies for sale is exacerbating high multiples.
Just because there are lots of buyers with deep pockets, this does not mean that the sales process has relaxed. In fact, the opposite is true. With higher multiples comes tighter margins and less room for error. Due diligence processes continue to be thorough and, with multiple interested parties, can be exhausting for all parties – deal fatigue is real.
The outlook for 2016
According to a survey completed by the CVCA, entrepreneurs expect that IPO activity will decrease in 2016 but that total merger and acquisition activity will remain the same, suggesting that there will be a relative increase in the number of private transactions. Strategic buyers – and the amount of dry equity powder – will keep valuations high. While the number of leveraged buyouts will likely decrease if/when interest rates rise, it may not be enough to reduce valuations significantly. In light of high valuations, lenders will keep a close eye on leverage levels, and may require more equity in deals.
Alternative products, such as First West Capital subordinated or mezzanine debt, can be used to bridge the gap between bank requirements and those of equity investors. The limited supply of strong targets with no shortage of financing available from senior lenders, strategic acquirers and private equity firms is expected to lead to continued, high valuation multiples for strong companies. The uncertain economy and oil prices will decrease confidence leading to more rigorous due diligence and a potential increase in earn-outs and other methods of making the purchase price variable.
First West Capital offers an alternative solution for financing acquisitions where the amount of equity is too small for many private equity firms or the buyer does not want to relinquish any control.