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Market Overview

• Lower middle market private equity deal activity tracked by GF Data Resources decreased 52% from Q4 2010 to Q1 2011
• Despite fewer lower middle market private equity deals, valuations of completed deals remained in line with Q4 2010 valuations
• Levels of private equity and strategic buyer “dry powder” remain high, and M&A continues to be a priority for both in 2011
• While well below the Q4 2010 spike, total US M&A activity in Q1 2011 is up 15% over the same quarter last year

Closed US M&A Volume  (Source – CapitalIQ)

In our last update, we talked a lot about uncertainty in the economy. Jobs reports, commodity prices, stock market indices…all were volatile, and little consensus could be found. Well, here we are roughly a quarter later, and not much appears to have changed on the macroeconomic front. 

Within the lower middle market, our anecdotal experience over the past quarter indicates that some trends may be emerging. The number of private equity firms knocking on our door in search of deals seems to have picked up from last quarter. We have heard from several of them that the rush of activity in Q4 was overwhelming and that they needed Q1 of this year to catch their breath. However, now they’re back and actively seeking acquisition opportunities. At the same time, closely-held, family-owned companies with whom we work are seeing improved financial performance and are starting to inquire about selling. Taken together, those trends may point to the remainder of 2011 being a dynamic M&A market.

Winded From the Q4 Sprint

After an active Q4 of 2010, the markets appear to have taken a breather. According to lower middle market private equity transaction aggregator GF Data Resources, activity dropped 52% from Q4 2010 to Q1 2011. Historically, activity is expected to drop from Q4 of one year to Q1 of the next, but this past year’s drop was more pronounced than normal. Most agree that expected tax increases (which did not materialize) drove an exceptionally active Q4 2010. 

Valuations Remain Steady

For the past three quarters, valuations for lower middle market private equity transactions have held steady at 6.1x adjusted EBITDA. Larger companies are commanding significantly higher multiples, though the premium being paid for “quality” companies narrowed in Q1.

Debt Market Improvement

According to Standard & Poor’s, new debt issues in the pipeline are up twofold from this time last year, and spreads for loans with a 3-year amortization are down almost 100 basis points from this time last year. Additionally, GF Data reports that Total Debt/EBITDA multiples have been steady around 3x over the past three quarters.

On the Horizon

The Q1 2011 slowdown should be only a momentary pause. Buyers have re-entered the market after catching their breath, and while there may be a lag for them to find and close new deals, the balance of 2011 should see vibrant M&A activity from both strategic and financial buyers.

*Data in this report is used with permission from GF Data Resources, LLC. All recipients agree to be subject to, and comply with the GF Data Resources Terms of Use.