Small and Middle Market Update
Despite the volatility of the public markets in the first quarter of 2022, privately-held small and middle-market company pricing increased during the period. According to the DealStats Value Index, which tracks private company transactions, the average enterprise value- (“EV”) to-net sales multiple increased to 0.64x in the first quarter of 2022, from 0.58x reported in the prior quarter. Moreover, the average EV-to-net sales multiple observed during the first quarter of 2022 was notably higher than the average multiple during the last six years (approximately 0.50x). From a profitability standpoint, the average earnings before interest, taxes, depreciation, and amortization (“EBITDA”) margin reported for first quarter 2022 transactions was the highest in the last six years at 17.0 percent. This higher EBITDA margin during the first quarter of 2022 may explain the higher-than-average EV-to-net sales multiple described above. Nevertheless, the average EV-to-EBITDA multiple also increased in the first quarter of 2022, from 3.9x in the previous quarter to 4.5x.
GF Data provides valuation data on private equity sponsored transactions for middle market companies, those with EVs between $10.0 million and $500.0 million. For the first quarter of 2022, GF Data reported that middle-market companies traded at an average EBITDA multiple of 7.3x, the same average EBITDA multiple observed during 2021. We note that size seems to be a key factor in transaction pricing, as companies with an EV ranging from $10.0 million to $25.0 million transacted at an average of 6.2x EBITDA, while companies with an EV ranging from $100.0 million to $250.0 million transacted at an average of 9.0x EBITDA, during the first quarter of 2022. However, the number of transactions of middle-market companies declined. Transaction volume totaled 56 deals in the latest quarter, compared to 119 transactions in the first quarter of 2021. As such, the first quarter of 2022 saw the lowest number of transactions of any quarter since the onset of the pandemic (2nd quarter of 2020).
Preparing for a Transaction
The transaction environment following the pandemic has presented new challenges for sellers, as they must explain to potential buyers what the “return to normal” or “new normal” looks like for the business. This issue was recently studied by researchers at Colorado State University who examined business sales during the 2007 to 2009 financial crisis. The researchers were surprised to find that the average spread between asking price and sale price decreased, indicating that sellers were efficiently communicating and aligning asking prices with market value prior to the sales process.
Per BVR’s Business Valuation Update (Volume 28, Number 6), the researchers suggested sellers, in the current post-pandemic environment, consider various seller financing options, temper value expectations, postpone the sale of the company until any perceived operating risk abates, and reduce information asymmetry. We understand that sellers can reduce information asymmetry by having reviewed/audited financial statements, ensuring all cash transactions are recorded, removing discretionary expenses from the books, documenting processes and procedures, cross-training employees, having the former owner transition to a lesser role (to reduce concerns of whether the owner exits the business), and finally, obtaining a third-party business valuation to support the asking price of the company.