Exit Preparation

Mixed Signals: Multiples in the Middle Market vs. the Main Street Market

A rising tide lifts all boats they say, but the little boats aren’t floating quite as high as the bigger boats. I’m talking about the so-called “Main Street” companies vs. the “Middle Market” companies. Two reports came out recently that illustrate the differences. Pratt’s Stats latest quarterly report gave some insight into Main Street businesses, with three categories of enterprise value: < $1 million, $1-5 million and > $5 million. The under $1 million category is what we truly consider Main Street, while >$5 million is lower middle market around here. GF Data Resources provided a report on what’s been happening in the true lower middle market with enterprise values ranging from $10 million – $250 million. Each report had a restricted set of buyer types: Pratt’s stats included only “private” buyers and excluded public company buyers. GF Data Resources includes only data from a specific subset of private buyers – private equity groups. By excluding certain public company buyers, what we might call strategic buyers, there’s a possibility that the results might be biased low in terms of purchase price and reported multiple. Nevertheless, the trends are interesting and to me the story is that Happy Times are Here Again for the larger companies, but the smaller firms are still trying to find their way to the party. Here’s a summary of what these two entities reported:

Lower Middle Market (From GF Data Resources: All industries, $10-250 million enterprise value, private equity deals):

Q1 2008235.6
Q2 2008345.6
Q3 2008356.2
Q4 2008315.9
Q1 2009156.2
Q2 2009166.5
Q3 2009205.1
Q4 2009205.4
Q1 2010175.2
Q2 2010305.5
Q3 2010426.1
Q4 2010586.1

There are a couple of things to note in the middle market data. The number of done deals dropped significantly during the Great Recession (see the first half of 2009 when only the better companies sold at the higher multiples, and the remainder of 2009 and early 2010 when multiples were depressed), but in the second half of 2010 both the number of completed deals and the multiples recovered. The multiples in late 2010 seem to be more indicative of a market recovery than the “flight to quality” that we saw in early 2009. It seems reasonable to conclude that the market has recovered for middle market companies in this size range.

Main Street and Above (from Pratt’s Stats Private Deal Update: All industries, private buyers):

Median Multiples for Companies with Enterprise Value Less Than $1 Million


Median Multiples for Companies with Enterprise Value Between $1 Million and $5 Million


**EBIT = Earnings Before interest and Income Tax

There was really no sign of multiple recovery in 2010 for these smaller companies. In fact the EBIT and EBITDA multiples reported in 2010 were the lowest median multiples reported in the last 8 years. Even though the broader economy is recovering and the stock market is reflecting strong performance at the upper end of our business world, down on Main Street a dollar of earnings is worth less than it has been in a long time. In 2006 the median buyer of a $500,000 company paid about $4.16 for $1 of EBITDA, but in 2010 the median buyer paid $2.10 for $1 of EBITDA – a reduction of almost 50%. In 2006 the median buyer of a $2 million company paid about $5.53 for $1 of EBITDA, but in 2010 the median buyer paid $3.31 for $1 of EBITDA. Waiting to sell in 2010 did not seem to pay off for the small business owners who held on through the depths of the recession in 2009.

Comparing the GF Data Resources data set and the Pratt’s Stats data set is revealing, and it indicates something about what I’ve called our “2-speed” economy. Things are getting much better in the deal world for larger businesses. The larger businesses are getting better. Buyers are interested, and more importantly, lenders are loaning more money to the buyers to get deals done in the lower middle market. For a business with more than $5 million EBITDA, Happy Times Are Here Again. Even the companies in the $1-5 million EBITDA range are doing OK, but not quite as well as their larger brethren. However, the smaller companies with less than a million in EBITDA (under $5 million in enterprise value) are still singing the blues. And for those with less than $1 million in revenue, well…Nobody Loves You When You’re Down and Out. Why has this happened? The timing is a little hard to explain, especially the big drop in multiples in 2010 compared to 2009, but the situation isn’t. Small businesses are viewed as being much riskier ventures than larger businesses, and the very small businesses are the riskiest. This has always been true, and small businesses have always received lower multiples than large businesses. In past recessions, the market for very small businesses was buoyed by laid off executives who decided to quit working for “the man” and buy their own business. That didn’t happen this time. Those individual buyers stayed on the sidelines or the unemployment lines. The appetite for small business risk among individual investors, banks, and many other buyers was nearly extinguished. The Pratt’s Stats data seems to indicate that there is still little appetite for small business risk, especially really small business risk among buyers, and consequently the buyers who are getting deals done are walking away from the closing table with what would seem to be fantastic bargains.

What’s the take away message for deals with private buyers from all of the above, plus what I’ve seen personally?

Your Company EBITDAMarket For Your Company
Over $5 millionGreat – Normal or Somewhat Better
$1-5 millionGood – Close to Normal
Under $1 millionBelow Historical Average
Under $500KWell Below Historical Average

That’s the “2-speed economy” for business sellers and private buyers through 2010, at least it’s my interpretation based on these 2 data sources.

Big Caveat: No public buyers were included in these data. These public company buyers and other large industry buyers (“Strategic” buyers) have been the most active in the marketplace lately. I reported in November that strategic buyers had accounted for 92% of all deals in the first part of 2010. They can afford to pay more than private buyers for strategic reasons. If you have a company with less than $1 million EBITDA those strategic buyers are probably your best bet for a decent multiple. There are definitely deals to be had in today’s marketplace if you know where to look.

A word to the wise: One buyer is not enough. You need to work hard to get your best deal and that means creating a confidential, competitive market for the sale of your business. This is especially true for smaller businesses. I’d be willing to bet that a lot of the sellers in the small sales summarized above took the first offer that walked in the door. That’s not the way to get your best price.

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