The Mergers and Acquisitions (“M&A”) market has seen significant growth during the last seven years. Overall M&A transactions have increased from approximately 12,000 per year in 2009 to nearly 22,000 transactions in 2015. Deal volume has seen similar growth during the period, increasing from $800 billion to $1.5 trillion between 2009 and 2015.
In addition to an increase in transactions and deal volume, M&A deals have seen a substantial increase in valuation multiples. Enterprise value to EBITDA is a common valuation multiple used in the M&A market. Between 2009 and 2015, the multiple has increased from 8.2 to 11.0. The growth in valuation multiples has been driven by an increase in large company multiples. While small company multiples have remained relatively flat, large company multiples have increased from 12.0 to 16.1 over the seven year period.
The increasing gap between small company and large company multiples is caused by the significant decline in the total number of “investable” companies. Investable companies are seen as having significant growth opportunities and are very attractive for private equity groups (PEGs). The investable companies have survived the start-up phase and secured an initial round of financing. These firms typically grow at a rate four times greater than the economy and are responsible for the majority of new job creation.
Smaller investable companies may considered “add-ons” to PEGs existing platform portfolio companies. Many PEGs are purchasing add-on companies to boost their existing portfolio in an effort to increase the market size of their current holding companies. By increasing the size of these platform companies in their portfolios, PEGs are able to take advantage of the increasing gap in valuation multiples between small and large companies.
Fewer quality “investable” companies is an increasing issue for PEGs, as the amount of investable cash is at an all-time high. This capital overhang must be put to work. Increasingly, PEGs are transacting with other PEGs to do so. Because of the increased valuation multiples and the older vintage of many funds, PEGs are increasing their sales of portfolio companies. The ratio of PEGs investments to exits fell to 1.7x in 2015, which is at historically low levels.
This need to put capital to work has cause many PEGs to use additional sources of deal funding. PEGs are using many sources of debt to fund transactions. Traditional banks will account for only 40 percent of deal financing in 2016, with a much lower share of small companies. As buyers acquire more funds, many new deals are funded by the PEGs themselves.
Continued growth is on the horizon. The number of companies likely to be sold as baby boomers retire is increasing. In addition, 44 percent of PEGs holdings were acquired before 2010 and are reaching the end of their holding period. With available cash for M&A transactions at an all-time high, and an expected influx of companies to hit the market, the private equity firms will continue to drive deal volume and valuation multiples.