Three months ago, it seemed that all the ingredients were in place for middle-market valuations to retreat from record levels. These ingredients included increased macro-economic uncertainty, a pullback in cash flow-based debt, and increased borrowing charges.
In fourth quarter of 2022, the retreat materialized. Valuations on deals completed in the quarter averaged 6.8x Trailing Twelve Months (TTM) adjusted EBITDA, down from 7.7x in the first nine months of the year.
GF Data’s 271 active private equity contributors reported on 64 transactions in the fourth quarter, meeting our base parameters—Total Enterprise Value (TEV) $10-250 million and TEV/Trailing Twelve Months (TTM) Adjusted EBITDA 3-18x—well off the record 172 deals recorded by GF Data in the fourth quarter of 2021.
Valuations cooled on markedly lower year-over-year volume. We attribute some of this to concern about corporate performance and the macro conditions referred to above.
Completed deal volume in the GF Data cohort exploded from 337 in 2020 to 470 in 2021. Deals deferred during the heart of the pandemic led to a bulge in the second half of 2021, particularly in the fourth quarter.
“While it seems clear many sellers and buyers were tapping the brakes in the second half of 2022, the extent of the year-over-year volume drop was magnified by the land-rush conditions in the prior year,” said Bob Dunn, GF Data’s managing director.
Over the past year, GF Data has paid close attention to the swelling “quality premium”—our measure of the spread in multiples applied to selling businesses with above-average financials compared to the rest of the pack.
The percentage of completed buyout transactions meeting our “above-average” designation jumped from the mid-50s to 54 percent in 2021 and 71 percent in the first nine months of ’22. With the conclusion of 4Q, that figure declined to 68 percent for the whole year.
This suggests an interesting reversal in the mindset of sellers of more and less desirable businesses. At the time that owners with better prospects were taking part in the “tapping the brakes” exercise described above.
“A subset of owners with less-favored businesses who’d been resisting sale concluded that it no longer made sense to wait out the market, and completed deals at more restrained pricing,” said Andy Greenberg, GF Data’s Founder.