One of the biggest takeaways in GF Data’s Q4 report (issued February ’23) shouldn’t come as a big surprise: The data set of 271 tracked PE firms reported 64 closed transactions, versus 172 in Q4 of 2021. 

It would appear that this softening was largely driven by the torrid catchup pace of deal closings in 2021, including the many deals backlogged by “height of Covid” delays in 2020. So while there was certainly some tapping of the brakes in the second half of 2022, the large gap seems more driven by the huge volume comparison to 2021.

Here are some key takeaways from GF Data’s Q4 report, which focuses on private M&A transactions valued from $10 to $250 million:

• There were 64 closed transactions in Q4 ‘22, compared to 172 in Q4 ‘21. 
• Valuations in Q4 averaged 6.8x EBITDA, down from 7.7x in the first nine months of 2022. 
• Buyouts with “above average” financials averaged a higher 7.9x multiple (68%) in 2022, in comparison to the historic norm of 56%. 
• There was a reduction in senior debt coverage on smaller deals valued between $10 and $25 million, and larger deals valued between $100 and $250 million.

A Look at Deal Volume

While deal volume may appear significantly down from Q4 2021, that doesn’t present an entirely clear picture. As noted above, the high number of deals closed the year prior was largely inflated by a Covid-driven backlog. Of course, economic factors like increased macroeconomic uncertainty, a pullback in cash flow-based debt, and rising interest rates

also contributed to the correction from record middle market valuations.

To get a complete picture, it’s helpful to look at the overall number of deals in 2022 compared to prior years. Overall, there were 297 deals closed among the GF Data survey for 2022, down from 470 in 2021. Despite the dramatic year-over-year difference, the number of deals closed in 2022 is actually within striking distance of pre-Covid year deals: 305 in 2018, 332 in 2019, and 337 closed deals in 2020. 

Above Average Financials Pay Dividends

Companies with above average financials continue to be rewarded with a higher payout multiple than those with average financials. In 2022, average buyouts received 6.3x EBITDA, while those with above average financials cashed in with a 7.9x multiple. While that’s down slightly from the above average multiple of 8.1x in 2021, it continues a mostly upward trend, up from 7.6x in 2019 and 7.7x in 2020

GF Data defines “above average” financials as businesses with TTM EBITDA margins and revenue and growth rates both above 10%, or one above 12% and the other metric at least 8%. 

Banks Pull Back on Senior Debt

Q4 revealed that some banks have pulled back on the amount of senior debt they put towards buyout transactions. The percentage of senior debt that banks were willing to commit to a buyout declined by .2x, from 3.7x EBITDA down to 3.5x EBITDA. This slight decrease means that subordinated debt is finding its way into more transactions than the prior year. 

Private equity players, who still have a reserve of dry powder, have been willing to commit more equity to transactions than usual in order to secure a quality asset. Those who put more equity in to close a deal now will undoubtedly refinance down the line when rates begin to moderate.

Dry Powder is Still in Play

The amount of dry powder, or undeployed private equity reserves from previously raised funding, also plays an important role in current marketplace conditions. There remains a surplus of private equity funds that must be deployed in the coming months and years.

Pitchbook reports that in 2022, there was a record estimated $2,477 billion of private equity “dry powder” reserves in the marketplace. Compare that to $2,095 billion in 2021, $1,914 billion in 2020 and $1,669 billion in 2019. Dry powder represents continued opportunity for business sellers in 2023, as it must be deployed within a defined timeframe.

What FourBridges is Seeing and Hearing

According to our friends over at Raymond James, while big institutional M&A deals have softened a bit, smaller owner / entrepreneur deals will likely remain steady due to demographics. Retirement-aged Baby Boomers who are ready to sell likely won’t sit on the sidelines and wait for a number of years, which means that deal volume here should hold steady.

And while overall deal volume was down in Q4, a managing director colleague at a Chicago-based private equity firm reports that as of early March, both deal volume and quality are showing signs of ticking back up in 2023.

Meanwhile, many sectors remained strong through 2022, as Four Bridges experienced with the closing of the sale of IER Electrical in January. The Houston-based electrical component manufacturer was acquired by Chicago Switchboard, Inc, a portfolio company of private equity fund Promise Holdings. IER benefited from the on-shoring of manufacturing back to the U.S., a boost for many industries, along with the strength of continued investment in the electrical grid. 

What Does the Current Market Mean for Businesses?

In a tightened marketplace like this, companies with solid financial prospects are best positioned to stand apart from the pack and attract the dry powder that’s currently sitting in the private equity vaults. Now is the time to stick to your knitting and keep your eye on your margins. 

In 2022, many companies were impacted by labor, supply chain and inflationary issues. As a result, many weren’t able to raise prices as quickly as their cost of goods sold rose during that time frame.

Many companies will begin to normalize in 2023 as these outside factors ease up. As your margins begin to get back to historical levels, this is a good time to paint a picture of what your “new normal” looks like for sellers. We’ve seen that buyers have been receptive to this type of outlook.

Recent Private Equity Transactions

Brighton Partners portfolio company Crew One Productions acquired the assets of Innercept Management Corporation, a provider of skilled temporary labor for concerts and other large events in South and Central Florida. FourBridges advised Crew One on its acquisition by Brighton in 2020.

LFM Capital has invested in a new portfolio company, APQS, a leading designer and manufacturer of longarm quilting machines used by hobbyist and professional quilters.

Kian Capital-backed SPATCO Energy Solutions (“SPATCO”), an infrastructure services provider for petroleum, environmental and EV market segments, completed the acquisition of Petro Supply, a leading distributor of petroleum equipment in the Mid-Atlantic region.