Overall M&A Market Commentary

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1 Overall M&A Market Commentary Middle market M&A activity continued its decline in 3Q17, recording another quarter of lower deal volume and lower dollar value. While on the surface this is disconcerting, there appears to be reason for optimism for a trend change. Quarterly GDP growth has started to show improvement above the trend line of 2%. The third revision of 2Q17 GDP growth was 3.1%, up from the second estimate of 3.0% and above the 3.0% barrier that many economists believe is difficult to achieve. While recent hurricanes and continued political uncertainty are expected to produce a drag on GDP for the last half of 2017, the consensus expected 2017 GDP is in the mid-two percent range. Further, the Michigan Consumer Confidence Index and the NFIB Small Business Optimism Index are both trending higher reflecting rising consumer and business owner optimism. Business optimism is strong. A recession does not appear to be in our near term future. The cause for optimism? The duration of the post-recession economic expansion is reaching record territory. If the current economic expansion lasts another year and a half, it ll be the longest on record, even surpassing the expansion of the 1990 s that ended in early 2001, said Brian Wesbury, Chief Economist of First Trust Advisors and former Chief Economist of the Joint Economic Committee of the U.S. Congress. He continued, Notice how we didn t say it ll be the best expansion of all-time, just the longest; it s not the best by a long shot. From the recession bottom to the expansion peak, real GDP expanded 39% in the 1980s and 43% in the 1990s. So far, eight years in, this one is only up 19%. That s why we ve been calling it the Plow Horse Economy. However, Wesbury s Plow Horse Economy, combined with consumer and business optimism has produced positive market sentiment. The DOW has advanced almost 25% since the election last November. Further, the S&P 500 has increased above $20 trillion in value for the first time in history. The improvement in the job market is also accelerating, producing more monthly full time jobs than in previous years. A belief that there will be additional reductions in business regulations, a continuation of a more business friendly government and some sort of tax reform could continue this optimism. The distracting partisan political drama in Washington has been the main media focus while the improving economy and stronger business earnings trends have been somewhat ignored. With improving corporate earnings and growth in the global economy, the positive trends in the financial markets are expected to continue.

2 boomer business owner is a far more common deal characteristic. As noted earlier, many analysts are predicting a Silver Tsunami of aging baby boomer business sales and this may be the early stage of that cycle. PE exit activity which has declined in previous quarters has started to reverse with the amount of capital exited increasing about 10% over the last quarter. It also appears as though the average size of the PE Company sold has increased over the last few quarters. Demographic trends cited earlier do not affect PEs, so it appears as though the PEs are again taking advantage of the high M&A valuations available in the market. The Silver Tsunami, the large number of baby boomer businesses needing corporate liquidity events, appears to be cresting, leading to more business owner interest in reviewing their strategic alternatives, including selling their businesses. The Silver Tsunami coupled with the economic tailwind could produce a more robust M&A market. While this report s closed M&A deal data has not yet provided support for the anticipated M&A market growth, we believe we are experiencing the early effects of this Silver Tsunami. Investment bankers and other advisors are reporting an escalation in M&A pitch activity and many advisors have seen an increase in the number of new engagements. There is a 6 to 12 month lag between engagement and transaction closing, so increases in this new engagement activity should lead to more closed deals in the coming quarters. Will there be another recession? Certainly! continues Wesbury. It is just very unlikely to start any time before spring of 2019, which means the current expansion looks set to become the longest on record. And if Congress and the President get their acts together and find a way to pass tax cuts or tax reform (or both), that should postpone the next recession even further into the future. The current M&A market favors sellers because the demand for good quality acquisition targets remains largely unsatisfied. We encourage business owners to look at their transition goals and objectives and determine whether a company sale makes sense for their circumstances. M&A Market Activity The closed M&A deal activity continues to be disappointing. Both dollar volume and number of deals had further declines during 3Q17, a trend which has continued for the last two years. As was the case last quarter, middle market investment bankers continue to report increased levels of pitch activity and have many new engagements in process in The 6 to 12 month lag between engagement signing and deal closing, suggests there could be a reversal of the negative trend noted above. Companies coming to market with an aging baby Deal valuations remained at relatively high levels. As the FED continues its interest rate increases, there could be greater downward pressure on valuations. But even with a gradual increase in interest rates, the lack of supply of quality companies for sale is expected to continue to support elevated valuations. The current market conditions are favorable to sellers, so business owners should take this opportunity to consider their strategic alternatives, including a company sale. The $32 billion of middle market deals recorded in 3Q17 reflects a 20% reduction in dollar value from 2Q17. Furthermore, the YTD17 dollar value of deals was down 31% compared to levels experienced in YTD16. The number of middle market deals recorded in 3Q17 declined 22% from the number of deals in 2Q17 and the number of deals closed during YTD17 as 41% lower than the number of deals closed in YTD16. The average middle market deal size of $46.4 million in YTD17 was up from the average $40.0 million deal size closed in YTD16. PE exit activity showed a slightly different story. The number of exits in 3Q17 decreased about 24% from the 2Q17 exits while

3 the capital exited increased about 10% over the same period. Demographic trends do not affect PE activity, so this is a good sign for market activity. Middle Market Deal Valuations In previous quarters our data indicated we were near a valuation peak or perhaps a plateau. The continued lack of supply of good company sale candidates and improving economic conditions are leading to more aggressive behavior by both strategic buyers and PE buyers. While valuation data cut by company size is particularly volatile at the present low levels of M&A activity, we are still beginning to see some interesting trend data. Valuations look like they are moving a little higher, suggesting we were at a plateau. If these elevated valuations continue through the end of the year, this may encourage more sellers to enter the market. This increased supply of deals coupled with higher interest rates could lead to declines in company valuations later this year or early next year. We believe middle market company values are still at or near a market peak and it is an excellent time for sellers to enter the market. Private Equity versus Strategic Valuations Strategic buyers are increasingly active M&A market participants. Better economic conditions and improving business sentiment are leading to more aggressive strategic buyer behavior in M&A transactions. Strategic buyer acquisition synergies have resulted in a long term trend of strategic buyers paying about 0.5x to 1.0x of EBITDA more than the PEs. Strategic buyers use M&A transactions to help increase their revenue and earnings growth. Our data for 2Q17 reflects more aggressive participation of the strategic buyer in M&A transactions leading to higher deal offers and increased strategic valuations. Sub-$25 million deal valuation multiples edged a little lower in 2Q17 averaging a 5.7x multiple which is the long run multiple average for this size category. Buyers continue to aggressively pursue deals across the middle market size spectrum. Valuations on the large end of the middle market ($50 to $100 million segment) moved dramatically higher in 2Q17 settling at 8.5x, a record high for this size group. Valuations in the $25 to $50 million segment also moved higher in 2Q17, reaching a record high of 7.1x Strategic buyers are becoming more aggressive and active in making middle market acquisitions. The 2Q17 data reflects a big increase in the premium a strategic acquirer is willing to pay over that of a PE buyer, although the dramatic size increase might be a reflection of the low number of deals observed in the quarter. Over the last few years, PE acquisition multiples have remained at a stable range. Our data show that the PE multiples have also broken out of that trend and increased during 2Q17 reaching a multiple level of 7.4x EBITDA. The increase in valuations indicates that the supply demand imbalance continues in the middle market. Well-prepared, attractive sellers can still take advantage of interest in M&A deals by both strategic buyers and PE funds and achieve reasonably high valuations. As we have suggested in our previous reports, properly prepared, The data reflect valuation multiples for all size deals. Prairie solid performing companies are always welcome in the M&A estimates that for middle market deals below $50 million, market and will continue to receive strong buyer interest and valuations are generally 1.0x to 2.0x multiples of EBITDA premium valuations. lower than the levels reflected in the table.

4 Middle Market Leveraged Buy Out Capitalizations Middle market LBO capital structures have continued to evolve as the deal community has become more comfortable with the continuation of the economic recovery and has taken advantage of the availability of debt capital. The amount of equity capital invested in the typical Leveraged Buyout ( LBO ) deal has continued to decline reaching a low point of only 40% of the capital structure. Growth in the number of lending sources, low interest rates and greater sophistication of borrowers has made the amount of debt capital employed an important part of the acquisition process. PEs, for example, use debt leverage to offset the effects that high Overall Comment on the Financing Markets Middle market loan issuance is starting to show some positive signs as consumer and business optimism improves. Following the extremely low levels of new issuance loan issuance in 2016, actually the lowest levels recorded since 2009, any improvement in loan growth is welcome news. There is evidence that capital spending is starting to improve, which could lead to additional loan volume to finance expansion. According to Kiplinger s September 2017 forecast on business equipment spending, New orders as well as shipments of finished goods are on the rise, giving U.S. businesses incentive to step up their investments in expanding production operations. Expect a 3%-4% increase in business investment spending this year relatively modest but a nice recovery from two lackluster years that saw no new investing. valuations have on their expected investment returns. Aggressive competition among banks and other debt sources for new lending opportunities has continued to keep borrowing costs low. The continuation of conservative deal structures and tighter lending terms reflects more stringent regulatory oversight of leveraged transactions and a more discerning lending community. The mezzanine funds continue to aggressively pursue deal opportunities in The use of this type of funding in leveraged transactions remains an important part of the LBO capital structure. While interest only and payment in kind structures still dominate the markets, warrants have started to return to the mezzanine return structure, particularly in smaller or more leveraged deal structures. Mezzanine funds continue to pursue equity co-investment opportunities to improve their returns and increase their investment amount in deals. Business optimism is starting to drive capital investment and loan growth. The Wells Fargo/Gallup 3Q17 U.S. Small-Business Index reflects that small-business owners optimism is at a ten year high. The index at 3Q17 was 106, up 11 points from 2Q17 and the highest since the index of 113 measured in 2Q07. According to the Wells Fargo/Gallup Report, Today s relatively strong index value occurs at a time when stock market indexes have reached record highs, unemployment is low, and reports indicate that the demand to buy small businesses is rising. With increased capital spending and more M&A volume, the demand for loans should rise. Even with the Fed s cumulative 100 basis point increase in interest rates, we remain in a low interest rate environment with low borrowing costs for businesses. Credit worthy companies with a need for long term debt capital are well received in the lending market. The current environment presents companies with an opportunity to borrow at a low interest rate. Total U.S. Middle Market Loan Issuance New loan issuance decreased slightly in 3Q17 indicating an improvement in new loan demand. An improving economy and better business owner sentiment may be contributing to more loan demand and therefore new loan issuance. The Federal Reserve increased its benchmark interest rate another 25 basis points in June This was the second 25 basis point increase in 2017 and the fourth 25 basis point increase since the end of the recession. The overnight funds rate target range is currently at 1.00% to 1.25%. Expectations remain for one additional rate increase in

5 The unemployment rate remains below 4.5%, currently at 4.2%. While job growth in the U.S. has been trending higher, the effects of the recent hurricanes may have a short term negative effect on job growth in later in the year. President Trump s focus on increasing U.S. jobs and more positive market psychology may still lead to more robust job growth later in Low LIBOR base rates coupled with stable lending spreads make this an attractive market for borrowers. December 2017 and additional increases in later years. Bank lenders continue to focus on relationship banking, corporate borrowers lines of credit and areas where they have a competitive advantage like operating business needs, including payroll and checking accounts. Due to regulatory scrutiny, banks continue to be selective in making new loans and are very selective in new leveraged transactions. The non-bank BDC ( Business Development Company ) lenders, due to their problems in attracting new funding, have reduced their participation in the leveraged loan market and have become more conservative in their lending practices. Interest Rate Environment Middle Market Debt Multiples Deal market debt leverage levels are creeping higher. Total leverage reached 4.2x with the bank part of the total leverage reaching 3.3x. More aggressive lender behavior, particularly on larger transactions, and improving economic conditions are providing support to deal market participants using increased leverage. Mezzanine capital remains an important part of a buyout capital structure. Over the last few years, mezzanine debt has represented a little less than 1.0x EBITDA. Mid-2017 was consistent with that level of mezzanine capital usage. The short end of the yield curve (Prime and 1 month LIBOR) are about basis points higher in year over year comparisons. This increase reflects the three 25 basis point Fed rate hikes in December 2016, March 2017 and June The market expects one additional Fed rate increase in late 2017, which will likely shift the low end of the curve higher later in the year. The long end of the yield curve (the five and ten year U.S. Treasuries) in year over year comparisons are up about 75 basis points reflecting the three Fed rate increases, shifting the yield curve up a little further. The slope of the yield curve (the difference between the yields on the short and long maturity bonds) is about 80 basis points which still reflects the market s same low inflation expectations. The use of debt leverage helps sustain high middle market M&A valuations. If interest rates rise significantly, the use of senior debt may decline somewhat putting downward pressure on M&A valuations.

6 Bank Financing Upfront Fees LIBOR Spread Asset Based Loans bps bps Cash Flow Loans EBITDA less than $10M: Unleveraged Loans 0-50 bps bps Leveraged Loans bps bps Cash Flow Loans EBITDA more than $10M: Unleveraged Loans 0-50 bps bps Leveraged Loans bps bps Bank lenders continue to maintain credit discipline largely to satisfy their regulators. The regulators limit the amount of HLT ( Highly Leveraged Transactions ) exposure that a bank can hold. Bank provided senior credit facilities remain at the relatively conservative 3.0x EBITDA senior debt ratio, so the slight increase in the use of senior debt is likely due to more aggressive, unregulated Business Development Company lenders. Mezzanine Debt <$10M EBITDA > $10M EBITDA Upfront Fees 2.00% 2.00% Current Pay Coupon 11.00%-13.00% 10.00%-12.00% Payment-in-Kind (PIK) Interest 0.00%-3.00% 0.00%-2.00% All in IRRs 14.00%-17.00% 10.00%-13.00% Source: Pricing is based on guidance provided by a number of commercial and mezzanine lenders Note: Warrants and other yield enhancements comprise the incremental return required to meet the all-in internal rate of return ( IRR ) About Kriz-Davis Co. Headquartered in Grand Island, Nebraska and founded in 1945, Kriz-Davis is a leading distributor of electrical products with 18 locations covering six states in the Midwest. As a full-line electrical distributor, the Company has continuously served the electrical utilities, industrial/automation, electrical contractor, and data communications markets while delivering value and innovation to the growing needs of its customers. Kriz-Davis Co. has been acquired by Border States Industries, Inc. About Prairie Capital Advisors Prairie offers investment banking, ESOP advisory and valuation services to support the growth and ownership transition strategies of middle-market companies. Headquartered in Oakbrook Terrace, Illinois, the company is a leading advisor to closely-held companies nationwide. Securities transactions are effected and offered through Prairie Capital Markets, LLC ( Prairie ), member FINRA/SIPC. This document is a result of Prairie Capital Market, LLC and is for informational purposes only. It is not intended as an offer or solicitation with respect to the sale or purchase of a security. The opinions expressed are the views of the writer and do not reflect the views and opinions of Prairie. Prairie shall not be liable for damages resulting from the use of or reliance upon the information presented herein.