The fourth Canadian issue of the monthly executive brief providing M&A market insight for C-level management and their professional advisors.
When a company is acquired, its purchase price is typically financed by the purchaser through one or more types of capital: equity, senior debt and mezzanine capital. Mezzanine capital has some features of debt (like a payment of interest or dividends) and some features of equity (like having a higher rate of return than debt and unsecured status). These funds sit between debt and equity on the balance sheets of the company, thus the name mezzanine.
When the purchase price of a deal is expressed in terms of a multiple of earnings (EBITDA), it is helpful to understand the role of each of these three components of the capital structure. Knowing how much of the financing comes from each source gives some insight into future market valuations of companies.
The table shows how these three financing components have worked together over the last six years (for private-equity sponsored M&A transactions with a total enterprise value between $10 and $25 million). When we look at the total valuation multiples, data shows that the multiples have remained fairly constant. What has varied, however, are the relative amounts of debt and equity compared to each other. This relationship has shifted significantly during the past six years. When we examine the mezzanine financing component (which includes both 3rd party and seller notes), we see that the fluctuation has been relatively minor. The senior debt and equity, then, become the varying components. As borrowing became more difficult in the 2008 to 2009 timeframe, buyers were forced to contribute larger equity stakes to complete a transaction. Inversely, as lending constraints eased and money flowed more freely, buyers migrated back to more highly leveraged capital structures by increasing senior debt and reducing their own equity investment in the deals done in 2010 and 2011.
More readily available senior debt financing should have a positive impact on the purchase and sale of businesses. When the purchaser has less difficulty in arranging financing, the transaction structure can be less complex – and this should make it easier to get the deal over the finish line.
We expect this trend to be truer in the US than in Canada – the Canadian banks adopted normalized lending practices several years ahead of the US banks. So Canadian transactions have already benefitted from the increased flow of debt capital, and now an increase is beginning to affect the US market as well.
The conditions are right for transactions that wouldn’t have been possible several years ago. If you’re interested in exploring the sale of your business, give us a call.
For additional information contact:
Douglas Nix, CA | Vice Chairman
Corporate Finance Associates | Toronto West | 905-845-4340 x211 | firstname.lastname@example.org