Inside the Lines of Private Equity

Since public equity prices have been stealing headlines, there isn’t much said on private company valuations.

This is a great business, lets pay up for this. I think 13.0x safely gets a management team meeting.

But it didn’t. This is a reality that many private equity firms are facing: an increasingly difficult environment to get deals done. It seems that multiples are continuing to increase, and private equity firms are forced to concede more and more aggressive add backs to the EBITDA that they are using to derive valuations.

But can’t the difference be made up in increased leverage? Sadly, it is more and more difficult to find the lenders able to underwrite to the higher leverage point. With lower rates and increased regulation, lenders have also felt the squeeze. (Thus the rise in non0traditional lending- but that is for another post)

So what does this mean for private equity? It should lead to more analysis and attention dedicated to downside cases. The economic reality is that with the customary hold period of 5–7 year, it lends to your firm holding new portfolio acquisitions through a downturn in the cycle. But getting full financials through the last downturn is more difficult. It has been 8 years since the 08' downturn. But having an accurate downside case should give firms more discipline around valuation and how much they are willing to pay for the underlying risk level of a business.

Source: PitchBook

After all, it is about setting a proper risk reward. Is paying 12.5x times for a business that you have a high probability of owning though a downturn prudent investing?

In summary, those winning in today’s market are business owners. If you are a business owner with no succession plan in place, it is very nice timing to run a sell side process.