U.S. Business Valuations Decline, with Valuation Gap Remaining a Major Obstacle to Deal Closure
Business valuations - the primary means by which businesses are evaluated in the investment process - are declining for the first time since 2010, according to new results from the 2017 Private Capital Markets Project from Pepperdine Graziadio School of Business and Management.
Survey respondents from investment banks reported that technology company valuation multiples dropped from 10 to 8.5 times recast EBITDA (Earnings Before Interest Taxes Depreciation and Amortization) for firms with EBITDA between $25-50 million, suggesting the perception of lower growth opportunities by investors. The declines are similar for other deal sizes, which are also coming down from their peaks in 2015-16.
Thirty percent of investment bankers cited the valuation gap as the top reason for private business transactions not closing. Of those deals that failed to close, due to a gap in pricing, approximately 64 percent had a valuation gap between 11 percent and 30 percent. Twenty-one percent named unreasonable seller/buyer demand as a top reason that deals failed to close.
Approximately 32 percent of angel investors, often considered "high-risk, high-reward" early investors, said they based their valuations of privately-held businesses on "gut feel." The report also found that angel investors had the highest cost of capital across all investment sectors, with a median required rate of return of 60 percent for seed investments.
"After years of very high valuations, likely fueled by the unnaturally low interest rate environment, this year's survey found that valuations now appear to be coming down to a more realistic level," said Craig R. Everett, Ph.D., assistant professor of finance and director of the Pepperdine Private Capital Markets Project. "Investors still have a lot of dry powder and are chasing quality targets, so unless there is some external shock to the markets, valuations will probably remain healthy for the foreseeable future. But i is good to see the valuation multiples coming down gradually off their highs."
The 2017 Private Capital Markets Project report, the nation's most comprehensive and simultaneous investigation of the major private capital market segments, is available here.
The report also found a 43 percent increase in the number of investment bankers that believe that strategic buyer deal-making has increased in the last 12 months, compared to 2016. Strategic buyers invest synergistically to enhance the long-term value of their company. Financial buyers, on the other hand, invest to increase the value of their portfolio of businesses over the next three to five years.
"The increase in strategic buyers is good news for founders, because strategic buyers often are willing to pay the most for an acquisition," said Dr. Everett. "This is because strategic buyers are more willing to pay for synergies than financial buyers."
Other key findings include:
· More private equity investors reported that the demand for private equity has increased in the last 12 months as compared to last year's survey (52 percent versus 42 percent), but more respondents expect returns on new investments to decrease (36 percent) rather than increase (20 percent) in the upcoming 12 months.
· Limited partners - those who can invest, but not actively participate in management decisions - cited the healthcare and biotech industry as offering the best risk/return tradeoff (20 percent), followed by information technology (13 percent). Ten percent named basic materials and energy as offering the best risk/return.
· Forty-four percent of venture capitalists expect an increase in the size of the venture capital industry over the next 12 months, and seventy-two percent anticipate an increased demand for venture capital. Thirty-nine percent of venture capitalists anticipate an increase in expected returns on new investments over the next 12 months.
· Nearly 88 percent of business owner respondents report having the enthusiasm to execute growth strategies, yet just 51 percent report having the necessary financial resources to successfully execute growth strategies. More business owners indicated that "bank loans" were their most appealing manner of obtaining financing than any other financing option.
· Generally, business owners appear optimistic about their futures, with annual revenues expected to grow by an average of 9.4 percent over the next 12 months.
The Pepperdine Private Capital Markets report survey investigates, for each private capital market segment, the important benchmarks that must be met in order to qualify for capital, how much capital is typically accessible, what the required returns are for extending capital in today's economic environment, and outlooks on demand for various capital types, interest rates, and the economy in general.
About the Pepperdine Graziadio School of Business and Management
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