2015 M&A and Capital Markets Update – A Sellers Market but for How Long?

Today’s Presenters

Joseph Durnford CEO

David Barnes Managing Director

Jeffrey Sasakura Senior Vice President

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What to Expect From This Webinar

1• Middle Market M&A Volume, Multiples and Industry

Trends – Why the Record Prices?

2• Dealmakers Insight – Recent changes in how deals

are structured, financed and won

3• Sell Side Perspective – Best Practices for

maximizing value and determining if now is the right time to sell

4• Private Equity Update –  The Private Equity formula

for creating value for buyers and sellers

OneMiddle Market M&A Volume, Multiples and Industry Trends

Jeffrey Sasakura Senior Vice President

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Sustained Rebound in M&A Activity

Number of Announced Deals by Sector Annually

• As we expected, continued pursuit of growth by strategic in economically unexciting times resulted in a rebound in M&A activity in 2014 and so far in 2015 after volume dipped significantly in 2013

• Additionally, increased availability of leverage for private equity firms has helped them compete with strategic valuation and continue doing deals at a steady pace, yet Private Equity were net sellers in 2014 and YTD 2015

• M&A markets are robust and seller-friendly for quality companies with strong valuations for sellers and healthy competition among buyers

Recent Transaction Activity

Source: CapTarget

2011

2012

2013

2014

2015 TTM

0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000

1230

1253

1125

1391

1374

91

104

99

81

83

120

121

102

128

128

195

175

169

188

196

471

472

474

691

703

351

444

307

397

408

345

348

305

333

327

80

70

62

77

77

894

875

866

1091

1110

420

403

363

466

446

239

231

211

267

257

295

309

266

367

348

127

126

72

107

112

243

212

191

250

249

439

495

411

516

504

197

216

225

274

270

1185

1253

1085

1326

1403

150

166

161

154

139

120

90

108

115

110

Commercial ServicesCommunicationsConsumer DurablesConsumer Non-DurablesConsumer ServicesDistribution ServicesElectronic TechnologyEnergy MineralsFinanceHealth ServicesHealth TechnologyIndustrial ServicesNon-Energy MineralsProcess IndustriesProducer ManufacturingRetail TradeTechnology ServicesTransportationUtilities

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Multiple Trends by Sector

Revenue Multiples by Sector (Cont.)

Revenue Multiples by Sector

Source: CapTarget

Commercial Services

Communications Consumer Durables

Consumer Non-Durables

Consumer Services

Distribution Services

Electronic Technology

Energy Minerals Finance Health Services0.0x

1.0x

2.0x

3.0x

4.0x

5.0x

6.0x

7.0x

2.0x 1.7x1.2x 1.5x 1.7x

1.1x2.1x

3.7x3.0x

1.4x

2010 2011 2012 2013 2014 2015 TTM Average

Health

Techn

ology

Indust

rial S

ervice

s

Non-En

ergy M

ineral

s

Proces

s Indu

stries

Produ

cer Man

ufactu

ring

Retai

l Trad

e

Techn

ology

Servi

ces

Transp

ortati

on

Utilitie

s0.0x0.5x1.0x1.5x2.0x2.5x3.0x3.5x4.0x

3.1x

1.4x2.0x

1.5x 1.5x0.7x

3.1x

0.7x

2.5x

2010 2011 2012 2013 2014 2015 TTM Average

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Multiple Trends by Sector

EBITDA Multiples by Sector (Cont.)

EBITDA Multiples by Sector

Source: CapTarget

Commerc

ial Se

rvices

Commun

icatio

ns

Consu

mer Dura

bles

Consu

mer Non

-Durable

s

Consu

mer Se

rvices

Distrib

ution

Servi

ces

Electr

onic T

echno

logy

Energ

y Mine

rals

Finan

ce

Health

Servi

ces0.0x4.0x8.0x

12.0x16.0x20.0x

9.5x 8.1x 7.9x10.6x

8.1x 10.2x 11.3x 10.5x7.7x 8.8x

2010 2011 2012 2013 2014 2015 TTM Average

Health

Techn

ology

Indust

rial S

ervice

s

Non-En

ergy M

ineral

s

Proces

s Indu

stries

Produ

cer Man

ufactu

ring

Retai

l Trad

e

Techn

ology

Servi

ces

Transp

ortati

on

Utilitie

s

Overall

Avera

ge0.0x2.0x4.0x6.0x8.0x

10.0x12.0x14.0x16.0x18.0x20.0x

11.6x9.8x

12.2x9.5x 10.7x

8.8x11.4x

7.9x10.3x 9.7x

2010 2011 2012 2013 2014 2015 TTM Average

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Multiples by Transaction Size

• In some industries, multiples for larger companies tend to be higher• Companies with less than $5 million in EBITDA have limited appeal to private equity groups

and thus should consider making acquisitions to expand EBITDA• Services industries have the smallest price size spread historically• Energy and industrial services have the largest size spread • Buyers have been willing to pay higher multiples for companies with larger cash flow and

stronger brand/market presence

Multiples Vary by Size

EBITDA Multiples for Total Enterprise Values (TEV) Above and Below $500 Million (2010-2015)

Source: CapTarget

Commerc

ial Se

rvices

Commun

icatio

ns

Consu

mer Dura

bles

Consu

mer Non

-Durable

s

Consu

mer Se

rvices

Distrib

ution

Servi

ces

Electr

onic T

echno

logy

Energ

y Mine

rals

Finan

ce

Health

Servi

ces

Health

Techn

ology

Indust

rial S

ervice

s

Non-En

ergy M

ineral

s

Proces

s Indu

stries

Produ

cer Man

ufactu

ring

Retai

l Trad

e

Techn

ology

Servi

ces

Transp

ortati

on

Utilitie

s

Grand T

otal

-

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

Avg EV/EBITDA Under 500mAvg EV/EBITDA Over 500m

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Strategic vs. Financial Buyers - Volume

• Strategic buyers always outpace private equity in terms of deal volume • Strategic buyers have continued to ramp up their deal activity since it dipped during the recession – deal

volume is at record highs• Private equity firms continue to do deals at a normal pace but their share of deals overall declined since 2013• The increasing competition for deals both within the private equity community and between private equity and

strategic buyers should prove to have a positive effect on valuations for sellers

Deal Volume by Buyer Type (US-Based Targets)

Source: CapTarget

20102011

20122013

2014Q1 2015 TTM

708733

677609

626625

6068 6458 6678

6012

76017629

FinancialStrategic

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S&P 1500 Constituents Total Cash & Equivalents ($ Millions)

Global Private Equity “Dry Powder” ($ Billions)

Strategic & Financial Buyers Are Flush with Cash

• Strategic buyers continue to have healthy balance sheets

• Cash balances spiked significantly at the end of 2014

• Members of the S&P 1500 ended the year with over $3 trillion in cash on their balance sheets

• Strategic buyers will continue to be active in the market in 2015 and have the liquidity to get and close deals quickly

Strategic Buyers

• The number of funds along with assets under management continue to grow

• Firms still have record levels of cash AKA “dry powder” to invest – increasing their equity available by $100 billion over 2013,. Now exceeding $1 Trillion of committed equity for investment

• Leverage markets have continued to open up and private equity have been able to increase valuations accordingly

Private Equity Buyers

Source: CapTarget

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q42008 2009 2010 2011 2012 2013 2014

-

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

$298$377 $407 $403 $406

$561

$801

$1,005 $1,071 $1,064 $992 $927 $943$1,062

$1,208

TwoDealmakers insight – Changes in how deals are structured, financed and won

Joseph Durnford CEO

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Actual vs. Trend Line M&A Volume

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Small Deal Market is Active

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Behind the Data – M&A Market Dynamics

1Energy Deals had peak valuations in Q3 2014 with multiples declining precipitously with decline in oil prices. Deal activity is increasing as strategic buyers acquire quality assets at distressed prices.

2Low Interest Rates and Solid Earnings Growth have resulted in higher valuations in many sectors as larger enterprises consolidate market positions to fuel top line growth. This has also resulted in increased use of leverage as % of TEV.

3

Private Equity deals are shifting away from complex capital structures to better alignment with sellers retained interest and to faciliate use of greater leverage.

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The Conference Board and PwC Measure of CEO Confidence™, declined in Q1 2015 from 68 in first half 2014 to 57. This corresponds with a slow down in deal initiations in Q1 2015, although Q1 ’15 saw an increase in closed deals.

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Sellers are demanding and getting better deal terms with fewer earnouts, seller notes and strict representations and warranties. Increasingly Reps & Warranties Insurance is being used to reduce Seller Indemnity Escrow.

6Quality acquisitions remain difficult to find as sellers remain reluctant to sell, due to lack of alternative investment yield. As equity markets improve sellers are becoming more willing to sell.

7

Private Equity firms have been selling to strategics and to other private equity firms to take advantage of high exit multiples.

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M&A Market Fundamentals are Sound

Sellers Market for M&A

Drivers:• Grow market share and

expand geographically• Numerous mega deals

completed in 2014, but add ons more common

• Significant cash is available to both strategic and financial buyers

• Private equity frims must deploy capital and are aggressive in searching for deals, but still risk averse

• New capital structures designed to position acquisitions for growth

Buyers SellersDrivers:• Regulatory compliance

costs • Age demographics

trending toward selling• Healthy earnings for

past few years increases value expectations

• Internally generted capital is available for distributions

• Becoming more difficult to find and retain next generation management

• Greed and desire for greater liquidity. Fear is not a driver, but be ware

ThreeSell Side Perspective Best Practices

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Finding Buyers

Know Thy Self

Leverage internal and

external networks

Use proven processes

Think inside and outside of

the box

Be committed and in play

• The first step in finding buyers interested in purchasing your business is to engage in a self assessment and perform pre-sale due diligence.

• Most strategic buyers are well aware of the companies operating within their competitive niche and they often have some degree of familiarity with rising stars or regional leaders

• Network with other CEO’s in your industry, via trade associations, industry trade shows and other events, may also want to attend Association for Corporate Growth meetings to network with financial buyers and deal pro’s

• Maintain relationship with investment bankers and stay abreast of deal activity in your industry. Take note when private equity firms purchase or sell a company in your sector

• When decision is made to pursue an exit, always use purposeful process and require transparency and accountability from deal professionals

• Develop a target buyer list of logical players and then add the non-congruent buyers who may find greater value than an industry insider

• Make a commitment to sell, do not “test the market” and be willing to “be in in play” as it may add millions to selling price

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Negotiating the Deal

Court multiple buyers to maximize seller leverage

Understanding the needs and motivation of the buyer

is often the most critical aspect of negotiating and

structuring a deal that works for both parties

Hire creative and experienced deal team to

assist in negotiating, price, terms, reps, warranties,

indemnities, reps/warranties insurance, deal timing, and overcoming the death of the

re-trade

Art & Science of ClosingWe recommend

companies negotiate a LOI with most or all

of the key terms upfront - then allow a brief period of buyer

exclusivity (30-60 days) for buyer to

conduct confirmatory due diligence and

demonstrate financing is in place

Have your own house in order and be prepared for

rigorous Quality of Earnings Analysis 

The courtship process must allow the buyer to conduct THOROUGH due diligence while protecting the seller

from a real competitive threat

After identifying the target, the process of courtship truly begins

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Negotiation Posture

Often Seller’s have more leverage than they think but not as much as they

want

Do not Negotiate Sequentially

Negotiate to achieve maximum

best overall outcome taking into account all factors

Understand your walkaways and

giveaways

Flexibility is key to success and

creativity is key to flexibility

Keep emotions in check and stay focused on end goals especially when your deal

goes in the ditch

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Is Now A Good Time to Sell•Lower Middle Market Purchase multiples are relatively steady, but will likely move downward if interest rates rise

•Buyers are willing to pay up for unique quality businesses

High Valuations

•Tax are currently stable, and somewhat predictable.

•Federal capital gain rates on sale of a business at 23.8% vs. maximum federal ordinary rates at 38%

Predictable Tax Outcomes

•Middle market companies are enjoying record profits and have strong balance sheets

•Easier to sell a thriving business during optimistic time

Business Cycle Timing

•Companies with less than $2M EBITDA being squeezed out of traditional senior lending market

•Larger enterprises have big advantage in accessing capital

Available Low Cost Debt

•Due to aging of baby boomers and smaller size of Gen X there are fewer inside managers or kids available to facilitate internal succession plans

•Baby boomers are being pressed by age, health and lifestyle preferences

Succession Planning

•Dealogic reported that Q1 2015 global M&A volume was the strongest Q1 since 2007

•Global interest rates pose threat to valuations and deal activity, when rates rise buyers will become more cautious and scarce

Supply & Demand

Is Now A Good Time to Sell?

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Sellability Overview In this sellers market, is your business ready

to sell? To answer that question, JD Ford & Company is

offering a Sellability analysis for participants of this Webinar.

CEO’s will learn how your business rates in the following key areas:

Financial Performance Growth Potential Switzerland Structure Cash Cycle Recurring Revenue Monopoly Control Customer Satisfaction Key Person Dependence

The questionnaire should take less than 30 minutes to complete, it is available at http://www.jdford.com/sellability_score.html

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10

20

30

40

50

60

70

80

90

1000

Sellability Score

FourPrivate Equity Update:The Private Equity formula for creating value for buyers and sellers

David Barnes Managing Director

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Not All Debt Created Equal

The availability and type of debt available is dependent on a couple of factors that make it more or less “attractive” (in terms of cost, risk and flexibility):

1. Market conditions2. Type of borrower: institutionally backed vs. individual borrower

Institutional

•More flexible covenants (less risk)•Equity cure rights (less risk)•Long-term relationship thinking (less risk)•Lower interest rates (cost)•Lower amortization (flexibility)

Individual

•Often requires personal guarantees (more risk)•Most of the cash flow based market is not available (cost, availability)

•Lender not general thinking long term about relationship (more risk)

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Private Equity & The Rational For Leverage

• Private Equity relies on debt in buyouts and transactions to help provide liquidity to shareholders upon buyout or recapitalization as well as to enhance returns for all shareholders upon harvesting of the investment

• Most private equity deals involve senior debt equivalent to 2.0x to 3.0x EBITDA of the selling company

• Most deals are leveraged less aggressively today than they have been in the past due to tighter banking covenants and more conservative investing approaches overall

• While business owners may be debt averse inherently, many private equity groups have learned to take a disciplined approach to utilizing leverage in a positive manner to achieve results that surpass those that would be obtained via the use of equity alone

Overview

• Assume a hypothetical recapitalization of a company with $15.4 million in EBITDA and an enterprise value of $100 million (6.5x multiple)

• The proposed transaction is to recapitalize the company with a 75% purchase of equity from the existing shareholders allowing them to retain 25% ownership in the new entity

• The private equity firm utilizes sr. debt in the transaction of 2.0x EBITDA or $30.8 million

• The private equity firm provides equity of $44.2 million• Capitalization and proceeds to shareholders is shown in the table

below:

Case Study Assumptions

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Case Study (Cont.)

• If the private equity firm didn’t use leverage the results of the transaction would be entirely different

• The results of two alternative transaction structures are shown in the tables: • Alternative 1: No debt, same proceeds to selling

shareholders• Alternative 2: No debt, same pro forma ownership

Effects of the Use of Leverage

Reduced Ownership %

Reduced Proceeds

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JD Ford & Company

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E-Mail: durnford@jdford.comWeb: www.jdford.com © 2014 JD Ford & Company LLC

Sources:

GF Data Resources

JD Ford & Company Proprietary Data

Prequin

Standard & Poor’s Capital IQ

Captarget