Small Business Investor Alliance Lower Middle Market Investment Insights Volume 5, Issue 1 1 SMALL BUSINESS INVESTOR ALLIANCE Lower Middle Market Investment Insights 2H 2018 Volume 5, Issue 1 March 2018
Small Business Investor Alliance Lower Middle Market Investment Insights Volume 5, Issue 1 2 Perspectives: Strong Revenue and Employment Growth Continues into 4Q Faraz Abbasi, Senior Partner Centerfield Capital Partners Much like the rest of the markets, the outlook for the lower middle market remains positive. We are seeing strong revenue and employment growth. Revenue growth remains much more stable than the S&P. Employment growth has also stabilized following the 1Q peak. Overall, this is one of the strongest years of employment growth recorded. All of this has given confidence to lower middle market executives, who are investing back in their businesses from IT to increased training and personnel. What is the Lower Middle Market? The lower middle market is a subset of the US economy that represents small to medium sized businesses. For purposes of this newsletter, we define the lower middle market as: Businesses that earn between $10mm and $100mm in annual revenues Deals for businesses with between $10mm and $100mm in total enterprise value Private Equity Funds that raise up to $500mm in capital The 2017 Tax Cuts and Jobs Act has had a positive effect, as most employers invested money back into the companies, though the data do not directly reflect this point. The challenge then for lower middle market employers will be sustaining this kind of robust growth. All industry segments experienced growth in 2017, as was seen in the broader middle market. With the national unemployment rate just above four percent, there is increased competition for retaining and recruiting talent. Addressing the skill gap is even a driver for M&A transactions, as firms see acquiring talent through acquisitions as a way to address staffing needs. The continued tightening of the labor market is also adding to employers concerns of rising costs from talent acquisition and retention to operations. This same anxiety is being felt throughout the whole of the middle market. Although not expected for the next couple of years, companies are preparing for the next economic downturn, which is fueling this anxiety. This is exactly why executives are preoccupied with retaining top talent and creating a high-growth culture that drives revenue these two attributes will help buffer any economic windfalls. Looking to 2018, lower middle market leaders remain optimistic, even with rising concern over healthcare and other costs. Employment growth is expected to slow and would reflect the shrinking size of the labor market.
Small Business Investor Alliance Lower Middle Market Investment Insights Volume 5, Issue 1 3 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 Lower Middle Market Business Indicators The National Center for the Middle Market (NCMM) conducts a quarterly survey of middle market businesses and provides us with data for lower middle market companies with $10 100 million in annual revenues. The data and our commentary below indicates how these businesses compare to larger firms on standard metrics like revenue and employment growth. We also feature the SBIA/NCMM Lower Middle Market Business Confidence Index, which combines revenue and employment growth in the preceding year, and expectations for revenue and employment growth in the following year. 10.00% 8.00% Revenue Growth (Last Twelve Months) Lower Middle Market vs. S&P 500 7.00% Employment Growth (Last Twelve Months) Lower Middle Market vs. Large Corp. (ADP) 6.00% 6.00% 4.00% 2.00% 5.00% 0.00% -2.00% -4.00% 4.00% 3.00% -6.00% -8.00% 2.00% -10.00% 1.00% Lower Middle Market S&P 500 Source: National Center for the Middle Market Lower Middle Market Large Corp. Source: National Center for the Middle Market, SBIA Estimates Revenue growth in the lower middle market dipped only slightly, as the S&P 500 continues to climb. Yearover-year revenue growth remains strong and is historically more stable than the S&P 500. 64 Incremental Investment Allocation Where would an extra dollar be allocated? 62 66 61 21 24 25 27 63 22 64 62 67 68 69 26 24 21 20 23 69 73 17 16 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 Hold Cash Reinvest in Business Spend on Acquisition Other Source: National Center for the Middle Market After hitting its peak at the beginning of the year, employment growth cooled to 5.3% in 2Q and has remained stable into 4Q. Hiring across the middle market remains strong. SBIA/NCMM Lower Middle Market Business Confidence Companies with Revenues between $10-100mm 120 118 116 114 112 110 108 106 104 102 100 98 Source: SBIA Estimates and NCMM Survey With continued strong revenue and employment growth, lower middle market companies are continuing to invest cash into their companies, investing in IT, training, and new personnel. Lower middle market executives continue to remain optimistic about the economy, even while major policy expectations have cooled.
42% 36% 38% 42% 43% 42% Small Business Investor Alliance Lower Middle Market Investment Insights Volume 5, Issue 1 4 52% 37% 48% 43% 48% 8.0X 7.8X 7.6X 7.4X 7.2X 7.0X 6.8X 6.6X 6.4X 6.2X Lower Middle Market Deal Trends Average Multiples and Deal Volume Deals between $10-250mm in Enterprise Value 6.0X 0 1H13 2H13 1H14 2H14 1H152H15 1H16 2H16 1H172H17 TEV/Adj. EBITDA (L) Number of Deals (R) 9.5 9.0 8.5 8.0 7.5 7.0 6.5 6.0 5.5 5.0 Valuation Multiples by Deal Size Total Enterprise Value/EBITDA for all Industries 1H 13 2H 13 1H 14 2H 14 1H 15 2H 15 1H 16 2H 16 1H 17 2H 17 $10-25mm $25-50mm $50-250mm See page 5 for more information on how to access GF Data s full reports and searchable valuation database. 100% 90% 80% 70% 60% 30% 20% 10% 140 120 100 Equity and Debt Contributions Smaller Deals between $10-50mm in Enterprise Value 0% 1H13 2H13 1H14 2H14 1H15 2H15 1H16 2H16 1H17 2H17 Equity Sub Debt Senior Debt 80 60 40 20 Based on completed deal activity in the GF Data universe, middle market valuations surged in the second half of 2017 to a record average of 7.8x Trailing Twelve Months (TTM) Adjusted EBITDA. Overall valuations for the year averaged 7.4x and surpassed the record high posted in 2016 in a data set that goes back to 2003. Two hundred and one private equity firms and other deal sponsors that are active contributors reported on 116 transactions completed in the second half of 2017 in the $10-250 million Total Enterprise Value (TEV) range, with valuations of 3-15x TTM Adjusted EBITDA. These firms reported 231 completed deals on the year meeting GF Data s specs, up from 220 in 2016. Other data highlights for 2017 include: Average debt utilization continued its upward trend from 2013--total debt averaged 3.7x in 2014, rose to 4.0x in 15 and 16, then hit 4.3x in 2017. This was driven by steady increases in senior debt utilization, from an average of 2.5x in 2013 to 3.4x in 2017. Larger deals within the GF Data cohort attracted the most debt, which helped drive a continued surge in valuation. At $50-250 million TEV, valuations averaged 9.2x EBITDA. Average equity contributions have fallen from nearly since 2013 to the 42% range in the first three quarters of 2017. The fourth quarter, however, saw a jump in average equity contribution to as rising valuations outpaced elevated but plateauing debt levels. Deals involving businesses with above average financials continued to garner a quality premium and accounted for the majority of the activity in the GF Data universe. The incidence was 60% in 2017 compared to 57% historically. 100% 90% 80% 70% 60% 30% 20% 10% Equity and Debt Contributions Larger Deals between $50-250mm in Enterprise Value 0% 1H13 2H13 1H14 2H14 1H15 2H15 1H16 2H16 1H17 2H17 Equity Sub Debt Senior Debt
Small Business Investor Alliance Lower Middle Market Investment Insights Volume 5, Issue 1 6 Disclaimers, Definitions, and Access to Data Disclaimer This newsletter is intended only for informational, educational, and research purposes, and should not be distributed or disseminated for commercial purposes without the permission of the Small Business Investor Alliance (SBIA). The information, facts, figures, data, and analysis included in this newsletter are believed to be accurate, reliable, and credible, however SBIA is not liable for any inaccuracies or errors in the information contained within. The newsletter does not, nor could it, take into account the needs, objectives, and financial situation of its subscribers and should not be considered as investment advice by the recipient. SBIA retains ownership of the contents of this newsletter and reserves the right to alter or make changes to the information retained within without notice to subscribers. Definitions 1. The SBIA/NCMM Lower Middle Market Business Confidence Index is an equal-weighted index based on four survey responses from the National Center for the Middle Market s Middle Market Indicator. The survey includes over 600 C-Suite executives of companies with annual revenues between $10mm and $100mm. The contributions to the index are: Revenue Growth, Employment Growth, Revenue Growth Expectations, and Employment Growth Expectations. GF Data To subscribe to GF Data s full reports and searchable valuation database, visit www.gfdata.com, or contact Bob Wegbreit at bw@gfdata.com or (610) 616-4607. National Center for the Middle Market More information about the Quarterly Middle Market Indicator survey, Benchmarking tools, and the Center can be found on their website: www.middlemarketcenter.org