State of the Middle Market M&A Private Equity Financing

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1 State of the Middle Market M&A Private Equity Financing Webcast: May 10, 2011 DEBT ADVISORY GROUP The Capital Markets Desk for the Middle Market

2 State of the Middle Market Agenda Agenda Update on Market Activity BDC Formation and Fundraising Predicted Evolution of the Senior Debt Market Alternative Financing Structures Capital Structure Considerations Speakers Ron Kahn Managing Director Phone: (312) Bob Horak Managing Director Phone: (312) Christine Tiseo Director Phone: (312) Lincoln International LLC 1

3 Middle Market M&A Activity Middle Market M&A Transaction Volume (LTM) Average Purchase Multiples of Middle Market LBOs Number of Transactions 2,500 2,000 1,500 1, ,321 1,797 1,663 1,677 1,602 2,047 2,107 1,845 1, ,415 1,521 $175 $150 $125 $100 $75 $50 Transaction Value ($ in Billions) 10.0x 8.0x 6.0x 4.0x 2.0x 5.9x 6.7x 7.0x 7.2x 8.5x 9.3x 8.1x 8.3x 6.6x 8.4x 6.5x 0 $ Mar-11 Number of Deals Transaction Value Source: Mergerstat 0.0x Q11 Source: Standard & Poor s Leveraged Commentary and Data Observations in the Middle Market M&A activity is continuing to recover, although more slowly than expected Liquidity in the middle market has continued to improve, but the M&A recovery has been moderated, in large part, by: Global and geo-political uncertainty Volatile swings in the prices of commodities (e.g., oil, gas) Mis-matched seller and buyer purchase price expectations M&A activity is expected to pick up significantly as a result of: The number of private equity investments with extended hold periods The substantial dry powder that private equity firms have available to deploy Pressure on strategics to grow in a low growth environment M&A markets are recovering, with this recovery expected to accelerate in the coming months 2011 Lincoln International LLC 2

4 Private Equity Drivers Private Equity Fundraising and Investing $500 $450 $400 Buyout PE Fund Equity Invested Cumulative Unspent Capital $350 $300 $250 $200 $150 $100 $50 $0 ($50) Source: Thomson Reuters LPC Median Holding Period of Private Equity Investments (Years) Source: PitchBook Corporate Cash On Hand and Movement in the Equity Markets Corporate Cash ($ in billions) $2,000 $1,800 $1,600 $1,400 $1,200 $1,000 $800 $600 2,000 1,800 1,600 1,400 1,200 1, Q04 3Q05 2Q06 1Q07 4Q07 3Q08 2Q09 1Q10 4Q10 Corporate Cash S&P 500 Source: Federal Reserve Reports; CapitalIQ 800 S&P 500 Index Value Trends in the Middle Market Financial sponsors have $400+ billion of capital to put to work and a strong desire to deploy this capital As of Q4 2010, the median holding period for a private equity investment was in excess of 5 years Strategic acquirers have an estimated $1.9 trillion of cash available for acquisitions and are more actively seeking acquisitions to supplement organic growth Strategics are an increasingly competitive threat to private equity firms in M&A auction processes As stock prices increase, acquisitions become less dilutive, enabling strategic buyers to pay higher prices 2011 Lincoln International LLC 3

5 Dividend Recapitalizations and Refinancing Transactions 2011 continues to be a robust year for middle market dividend recaps and refinancing transactions Middle Market Volume, Dividend Recap vs. LBO Loans Repricings, Refinancings and Recaps as % of Total Leveraged Loan Issuance $10.0 $8.0 $6.0 $4.0 $2.0 $0.0 4Q02 4Q03 4Q04 4Q05 4Q06 4Q07 4Q08 4Q09 4Q10 Div idend LBO 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 76% 64% 57% 57% 51% 47% 46% 54% 31% 36% 32% 15% Q11 Source: Thomson Reuters LPC Note: 4Q10 includes completed and in process deals Source: Standard & Poor s Leveraged Commentary and Data Observations For the first quarter 2011, leveraged loan volume climbed to levels comparable to the second quarter of 2007, a post-credit-crunch high However, new-money issuance was muted compared to repricings, refinancings and s, which together accounted for 76% of the total loan market and represented an unprecedented historical high The lack of new-money issuance drove lenders to accept more aggressive loan structures on dividend s, including tighter pricing, increased leverage and looser covenant packages While not yet evidenced in the data, loan arrangers and investment banks are expecting a material strengthening in LBO activity in the middle market Until M&A financing opportunities become more plentiful, lenders are likely to continue to be willing to finance dividend recaps at these high levels 2011 Lincoln International LLC 4

6 Impact of BDC Formation Last 36 Months of BDC Price / Share and BV / Share $20.00 $17.00 $14.00 $11.00 $8.00 $5.00 $2.00 Mar-08 Jun-08 Sep-08 Price per Share Dec-08 Mar-09 Jun-09 BV/Share Sep-09 Dec-09 Mar-10 Jun-10 Source: Capital IQ Note: Based on index created by Lincoln, consisting of 32 BDCs, as of March 31, 2011 Sep-10 Dec-10 The continuous improvement in BDCs overall stock performance and investors search for yield has enabled BDCs to raise both debt and equity capital and has spurred the entry of a number of new BDCs into the market With increased capital, BDCs have become, once again, significant players in the middle market and are especially well-suited to provide unitranche credit facilities In addition, a number of BDCs that are focused solely on making senior debt investments have begun to emerge However, dividend expectations and cost of capital for these BDCs may result in pricing that is higher than pricing required by more traditional senior financing sources (e.g., commercial banks, commercial finance companies) Mar-11 BDCs That Recently Went Public Name of BDC Golub Capital BDC THL Credit Full Circle Capital Horizon Technology Medley Capital Solar Senior Capital PennantPark Floating Rate Total Capital Raised Implied Lending Capacity (1:1 leverage) Date IPO Completed April 14, 2010 April 21, 2010 August 31, 2010 October 28, 2010 January 20, 2011 February 24, 2011 April 8, 2011 Capital Raised by Existing BDCs in 2011 Name of BDC Ares Capital Corporation* Fifth Street* Golub Capital BDC Hercules* Kohlberg Capital* Main Street Capital Medley Capital PennantPark Prospect Capital* Triangle Capital Total Capital Raised Implied Lending Capacity (1:1 leverage) Total Implied Lending Capacity (1:1 leverage) Capital Raised $107.4 million $121.4 million $18.0 million $100.0 million $138.7 million $160.0 million $100.5 million $746.0 million ~$1.5 billion Capital Raised $200.0 million $295.5 million $55.1 million $75.0 million $60.0 million $73.9 million $133.0 million $114.1 million $276.5 million $66.4 million $1.3 billion ~$2.7 billion ~$4.2 billion Source: BB&T Capital Markets, CapitalIQ, Company press releases *Issued convertible debt 2011 Lincoln International LLC 5

7 Bifurcation in the Senior Debt Market Alternative sources of capital are expected to continue filling a significant gap in the senior debt financing market ABL Many players Primarily banks Requires significant asset base Senior Debt Market Traditional Senior Cash Flow Very few players Very tight credit box Select commercial banks and finance companies Alternative Sources Increasing number of players More flexibility with products, structures and credit box Capital providers and their financing solutions continue to evolve to fit dynamic market conditions BDC Unitranche Non-Rated TLB Willing to finance storied or smaller businesses that command greater yields Provide funding throughout the capital structure and want to keep capital deployed (i.e., less required amortization) An alternative structure for larger middle market companies with EBITDA of at least $25 million Lincoln s predictions on the evolution of the Senior Debt Market Commentary The senior cash flow market remains limited for middle market companies due to too few players; thus, more storied credits, as well as smaller companies, typically have to look to the ABL market or alternative financing sources With CLO reinvestment periods ending and recently proposed regulations potentially making it difficult for CLOs to raise new investment vehicles, liquidity in the traditional senior cash flow market is likely to be hampered, with more companies needing to look to alternative sources for senior financing 2011 Lincoln International LLC 6

8 Unitranche An Evolving Structure Does the unitranche really provide for a simpler capital structure? Types of Unitranche Facilities (Illustrative Examples) First Dollar Revolver... $0 Term Loan... $100 ABL Revolver with Term Loan Revolver.. $40 Term Loan.. $60 ABL Revolver with First Out / Last Out Term Loan Revolver.. $40 First Out (TL).$30 Last Out (TL).$30 Each structure blends to the same overall price for the borrower Unitranche Considerations The unitranche loan was initially introduced to the market in the form of a first dollar in structure, with no other lender ahead of the unitranche provider in the capital structure Unitranche loans, in an effort to reduce pricing to the borrower, are often now structured behind an ABL revolver As market dynamics drive down the pricing across all debt layers, some unitranche providers are looking to tranche their facilities, in the form of first out / last out structures, so that they can maintain their historical yields Although the borrower s blended cost of capital is typically less than the cost of capital under the more traditional unitranche structures, this newest type of unitranche facility can result in more lenders in the capital structure, more complex governance provisions and challenging inter-creditor issues Unless a facility is tranched pre-closing, a borrower also will not know for certain which lenders will be in its capital structure 2011 Lincoln International LLC 7

9 The Non-Rated Term Loan B An emerging alternative for larger middle market credits CLOs in Reinvestment Period ($ in billions) $300 $250 $239 $200 $168 $150 $100 $55 $50 $5 $ Source: S&P, Wells Fargo Securities Commentary Broadly syndicated TLB market facing evolution as many CLOs reach the end of their reinvestment periods in the next 24 months Loan sizes of $200 million and below are often on the bubble First-time issuers with limited liquidity and rating constraints, which may be more storied credits Most impacted by unpredictable macro events / market changes New investors (i.e. retail loan funds) likely to prefer larger deals; other investors likely to require higher pricing A private, club deal offers lenders and borrowers a number of advantages relative to a publicly rated, broadly syndicated process Lender Characteristics Price makers who can take larger hold positions CLOs and other price takers not needed Liquidity is a lower priority Lender Advantages Larger hold sizes / outstandings; put more money to work More influence over the credit and documentation Ability to differentiate from competitors Enhanced relationship with borrower and sponsor Borrower Advantages Ability to customize capital structure; not limited by rating or locked into one structure (i.e. TLB) Pricing and terms set to meet issuer s objectives, while also meeting lender s needs Limited group (<5) of long-term, permanent lenders More control over composition of lender group Ability to pursue multiple structure alternatives (unitranche, etc.) concurrently with TLB Less likely to be subject to pricing or structure flex 2011 Lincoln International LLC 8

10 Overview of U.S. Middle Market Pricing and Terms Average Total Debt Multiples of Middle Market LBOs 6.0x 5.0x 4.0x 3.0x 2.0x 1.0x 0.0x x 4.7x 4.1x 4.0x 3.4x 3.9x 3.8x 4.2x 4.7x 4.7x x 4.5x 3.3x 4.2x 3.4x Q11 FLD/EBITDA SLD/EBITDA Other Sr Debt/EBITDA Sub Debt/EBITDA Source: Standard & Poor s Leveraged Commentary and Data Lincoln s View on Pricing and Terms Borrowers with less than $10 - $15mm EBITDA Average Equity Contribution in LBO Transactions 50% 45% 40% 35% 30% 25% Large Corporate Source: Standard & Poor s Leveraged Commentary and Data Middle Market Borrowers with at least $10 - $15mm EBITDA Q11 Pricing Multiples Pricing Multiples Asset Based Senior L LIBOR Floor: none n/a L LIBOR Floor: none n/a Cash Flow Senior L LIBOR Floor: x 3.50x EBITDA L LIBOR Floor: x 4.00x EBITDA Unitranche L LIBOR Floor: 200 L LIBOR Floor: nd Lien Loans Unlikely 3.50x 4.50x EBITDA L LIBOR Floor: x 5.50x EBITDA Sub Debt Cash of 11% - 13% PIK of 2% - 4% All-in of 14% - 16% Cash of 11% - 13% PIK of 1% - 3% All-in of 13% - 15% Equity n/a 35% - 40% n/a 35% - 40% 2011 Lincoln International LLC 9

11 Bringing Efficiency to the Middle Market Lincoln s Debt Advisory Group adds the following value to each assignment: Robust process ensures best available pricing and terms Strong relationships with over 300 capital sources throughout the world Multiple capital structure alternatives are generated which enhances certainty of closing Provides clients with transparency and control over financing process Lincoln s independence assures there is no conflict of interest Maximum leverage of time and resources for management team and financial sponsor Select Transactions that Recently Closed a portfolio company of refinancing $27,000,000 Senior Credit Facilities $7,500,000 Junior Capital refinancing in the amount of $44,500,000 Senior Credit Facilities $28,000,000 Second Lien Facilities a portfolio company of in the amount of $40,000,000 Junior Capital has acquired Lincoln International LLC arranged acquisition financing to support Marlin Equity Partners purchase of Phoenix Technologies Ltd. a portfolio company of $53,500,000 Senior Credit Facilities $40,000,000 Junior Capital an affiliate of $36,500,000 Senior Credit Facility a portfolio company of $20,000,000 Senior Credit Facility $78,000,000 Term Loans has refinanced its portfolio company $55,000,000 Senior Credit Facilities $30,000,000 Subordinated Debt has recapitalized its portfolio company with an investment from a portfolio company of 2011 Lincoln International LLC 10