The truth about valuations in 2014
Low interest rates. Ample bank financing. Record capital committed to private equity funds. The highest value of private-equity backed buyout deals since 2007.
These factors and others are contributing to intensifying deal competition, which means private equity firms on both sides of transactions must increasingly find an edge to win without taking excessive risks. Often, that edge is the deal price and the underlying valuation. Every valuation is unique and can make or break a deal.
“No private equity investor wants to admit to overpaying,” The New York Times reported recently. “But several say that, in the face of competing bids, they have been forced to sit on the sidelines more often than they would like.”
In fact, investment bankers and business brokers say roughly 30 percent of deals over the past 12 months terminated without closing, according to the most recent Pepperdine Private Capital Markets Survey. Both groups most often blamed valuation gaps for busted deals.
Deals are also closing more quickly, based on Pepperdine’s Fourth Quarter Report Market Pulse Survey, which focuses on businesses with values below $50 million being sold.
“It appears that 2014 is shaping up to be a perfect storm for M&A activity,” said Scott Bushkie, president of M&A advisory firm Cornerstone Business Services, in Pepperdine’s press release announcing the Market Pulse results. “Valuations are staying strong, sellers are gaining greater leverage, and boomer retirement is driving sellers to market. We are also seeing stronger support from traditional lenders, and that is enabling more corporations, Private Equity firms and individual buyers to come to the table, increasing an already record -size buyer pool.”
The deal environment means there is ongoing pressure to streamline the valuation process, yet it is more important than ever to calculate valuations that inspire deal parties’ confidence and allow you to win in all aspects of the transaction.
Valuations, of course, also affect private equity investment returns and management compensation, and in that regard, it’s clear that firms are increasingly under the regulatory microscope. Regulators want private equity firms to disclose valuation methodologies and to have compliance policies and procedures sufficient to ensure that firms’ performance data and marketing are supported by valuations calculated according to the firm’s chosen methodology.
Bruce Karpati, then -chief of the SEC Enforcement Division’s Asset Management Unit (AMU), told private equity firms during a 2013 conference, “You won’t see the Enforcement Division or the AMU shy away from cases that involve illiquid asset valuations or that require us to dig into the operations of a portfolio company.”
This need for defensible valuation methodologies is ongoing. “Interim valuations do, in fact, matter,” according to Karpati. “In the course of running their business, private equity managers often tweak strategies, change teams and raise funds of increasing size. While everyone understands that the true measure of value is a realization event, data from older realized investments may not be relevant to a decision to commit capital to a new fund and interim valuations may be the best data available to investors at any particular time.”
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