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Mid-Market M&A Update -- What We Know Now

By Nick Araco posted 09-21-2020 12:13 PM


As we sprint from Q3 to Q4, 2020, here is what we now know about Mid-Market M&A activities, according to GF Data and their CEO, Andy Greenberg:

Here’s what we know:

Volume fell off the table. GF Data contributors reported completed deal activity in 2Q at about 40% of the volume level in 1Q—and in the year-ago second quarter.

Valuations stayed aloft. Pricing on this markedly smaller cohort averaged 7.4x TTM Adjusted EBITDA in the second quarter—the same as in the first quarter, and within the trading range that has prevailed for the past several years.

There was remarkable consistency within deal size brackets. The 2Q marks by TEV range were: $10-25 million—6.1x; $25-50 million—6.9x; $50-100 million 8.4x; and $100-250 million—9.7x. None of these multiples varies by more than .2x from the corresponding figure for 1Q.

Deferred consideration mechanisms helped -- on smaller deals. One question widely asked in the last few months: has there been increased use of seller financing or earnouts to bridge valuation gaps? Use of these structuring devices rose from 35 percent in the first quarter to 39 percent, but deals in the $10-50 million bracket accounted for all of the pick-up. At $50-250 million, the incidence was essentially unchanged.

Favored sub-sectors remained active. Completed deals are publicly reported, so we have no proprietary window on composition by industry. However, our data does show with precision the extent to which sub-sectors rather than broader categories are finding favor. NAICS categories 5416 (IT consulting) and 4234 (health care related distribution) are two examples.

Debt retrenched immediately. Average total debt averaged 3.9x in 1Q—in line with overall averages going back to 2017. In 2Q, total debt fell to 3.3x.

Average equity share spiked. Static deal pricing with reduced debt meant more equity required to get deals done. Average equity contribution jumped eight percentage points, from 48.7 percent in the first quarter to 56.5 percent in the second.

Deal mix tilted to add-ons. Not surprising given these dynamics -- sponsors found it easier to complete additions to existing portfolio companies rather than to capitalize and close on new platforms. In 2017-19 platforms accounted for about 75 percent of our reported deal volume—fairly consistent from year to year. The first quarter saw a drop to 63%. In the second quarter, though, the figure was 45%.

Bank and non-bank lenders both receded. One trend noted in GF Data’s first quarter report was the convergence of commercial bank lenders straining to compete with non-banks, and non-bank lenders providing more conservative capital structures to acquirers preparing for a conventionally recessionary environment. That apparent trend was obliterated in 2Q. Average debt in uni-tranche deals continued to decline, from 3.6x to 3.0x. Average debt provided by commercial banks, however, plummeted from 4.0x to 2.6x.

Mezzanine financing stepped in. We have remarked before on the counter-cyclical resilience of this class of capital providers. The only “up” leverage metric from 1Q to 2Q was on average debt involving mezzanine/junior capital providers, where there was a jump from 3.7x to 4.6x.

Deals that closed commanded favorable key deal terms. The general cap on indemnification against breaches of reps continued a multi-year trend of decline, averaging 8.6% of TEV in 1Q and then dropping further to 6.7% in 2Q. While there was little movement in valuation across quarters, this may well be a comment on the robustness and risk profile of the select group of deals that did find the finish line this spring.

According to Andy:  We see no reason to expect radically different conditions for the balance of this year, and possibly the first quarter of 2021. Sellers a few months away from close are already interested in avoiding potential federal tax changes, which will pull some volume back into this year.  A groundswell of new product is being prepared for launch post-election.  Private equity funds and lending sources not focused in favored sub-sectors are now content to keep their powder dry and anticipate a more settled political and public health environment in a few months.  By then, we may know a lot.