Not long ago, owners of middle market companies could expect to sell their business at a reasonable value when they were ready for a transition. Their business didn't have to be the best performer, but rather operate comparably to the performance of their peers meeting decent middle-of-the-road metrics. Not so today! Many are experiencing what the market is calling the "Value Gap."
This gap manifests itself in a number of ways in terms of buyer interest, in terms of access to growth capital and in terms of valuation. In many instances it's not a matter of the value of the company being low or the cost of capital being high -- it is the absolute lack of any interest in financing or in acquiring the company at all.
For example, lower middle market businesses that haven't hit their stride or met their potential -- evidenced by slow growth rates, low gross margins or low EBITDA margins -- but are strategically positioned and attract buyer interest; these companies have seen a continued declined in EBITDA multiples paid by both strategics and financial buyers. On the other hand, the higher performing middle market companies with EBITDA greater than $8 million to $10 million are experiencing record high multiples, even higher than those in late 2007 and early 2008. To the point, the size of EBITDA does matter!
The value gap can be illustrated by the wide difference between what is referred to as "Owner Value" and "Market Value." Owner value is the required value in the M&A transaction by the shareholders of the selling company, whereas market value is the range of amounts that the market players place on a company based on their perspective and the market dynamics. In many cases, owner values have been driven higher by the lack of alternate investment opportunities post-closing that will yield returns with adequate cash flow to mirror those that the owners currently experience by holding their interest in their business. In many situations, market values for all but the high performers have been driven down ….thus the gap has widened.
Recent research and empirical evidence shows that the root problems causing this value gap for middle market companies are that:
- Companies don't generate returns adequate to cover their cost of capital, and
- Management isn't re-investing at an adequate rate to sustain growth and remain competitive and relevant in the market place long-term.