Deal-making for private companies, particularly those in the lower middle market (“LMM”) (defined as deals worth less than $100m), is notoriously opaque: few data points exist surrounding transaction values and acquisition multiples. The reason for this is simple: unlike the real estate industry, in which all transactions are published, private companies aren’t forced to disclose deal parameters.
As a seller, this poses a significant issue: how can you know what your business is worth when there are few comparable data points? Or, if you have been approached by a buyer, how can you know their offer is fair? Or perhaps an M&A advisory firm reached out to you; how much weight can you really put on their valuation guidance?
In this edition of FirePower’s Market Insights, we discuss the “information” gap in valuing companies in the LMM and draw on our deal-making experience to provide some visibility into how we can arrive at reasonable valuation conclusions in this typically opaque market.
Applying generally accepted valuation methodologies to the LMM
There are three main generally accepted methods of valuing a business: 1) comparing it to similar, publicly traded companies; 2) comparing it to similar precedent transactions; and 3) forecasting its future cash-flows and determining the value of those cash-flows today.
Methodologies 1) and 2) can readily be applied to value large companies, because the underlying data overwhelmingly comes from transactions involving large companies, both private and public. It is an apple to apple comparison.
When analyzing private companies in the LMM, these valuation approaches cannot be as readily used, as they don’t capture those companies’ unique characteristics and dynamics. For example, a publicly-traded manufacturer of stainless steel components with $1bn in sales globally and $100m in EBITDA may be valued at 12x EBITDA; it does not make sense to value a private manufacturer of similar products that generates $40m in sales and $4m in EBITDA using the same multiple.
To bridge this information gap in valuations in the LMM (recall, if we had “true” comparables, we could apply them), discounts are applied. In the example above, it may be reasonable to use a 30 – 50% discount (i.e. the private company is likely worth $24 – 34m). Appropriate discount factors are more “art” than “science”. And deal-makers in the LMM, like FirePower Capital, are tuned into these.
How does FirePower have an edge in valuing businesses in the Canadian LMM?
Ultimately, closing transactions in the LMM is the best way to know first-hand what discounts are appropriate.
The sole focus of our M&A practice is the LMM in Canada. Through our track record, we have gathered a volume of transactional data points across multiple industries that cannot be seen by acquirers, whether strategic or financial, or by our less active competitors. When representing sellers, we leverage this knowledge to minimize the discounts they face (i.e. we maximize value).
Our deal-making approach continually tests the upper bound of what buyers are willing to pay. It focuses on:
- telling compelling stories based on a deep understanding of our clients
- generating competitive bidding environments
- leveraging technology to individually connect with relevant buyers around the world
Volume and focus together are a potent combination that inevitably gives our clients the highest probability of transacting at low discounts relative to the valuation multiples that much larger comparable companies command.
Case Study: How FirePower outperformed the average valuation guidance by 40%
A Canadian manufacturer engaged FirePower to advise on selling 100% of the business. Our initial valuation guidance, based on public comparables and recent transactions, was in the 4.5x – 6x EBITDA range; that said, we flagged to our client’s board that it may command a premium, in a competitive auction process, because of the company’s better-than-average growth path, long-standing customer base, award-winning product line and top-tier leadership team that would continue to operate after a transaction.
We generated 6 offers of which 4 were strategic buyers that would see significant value in the business if it were in their hands. While most bids came in within the expected range, two European strategic buyers offered 8x EBITDA. It represented a significant premium above our initial guidance, though we did expect a few offers to be exceptionally strong, in light of our client’s differentiated drivers of value, combined with our story-telling, competitive auction process and technology-enabled outreach.
