fall 2009 private capital survey findings
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Fall 2009 Survey FindingsJanuary 27, 2010
John K. Paglia, Senior Researcher,Denney Academic Chair,
and Associate Professor of Finance
• Web-based survey that included banks, asset based lenders, mezzanine funds, private equity, venture capital, and privately-held companies
• Typical survey asked about firm profile, credit box, historical returns, expected returns, view of next 12 months
• Capital providers were surveyed in October and November 2009
• Over 700 responses
Private Capital Markets Survey
Banks ABLs Mezz PEGs VCs0%
10%
20%
30%
40%
50%
6.8%
13.0%
18.5%
25.0%
38.2%
Pepperdine Private Capital Market LineCost of Capital by Financing Source
Spring 2009 Fall 2009
• Tough Credit Environment– Despite fewer applications, the time to
process loans has increased– 82% report reductions in credit quality of
borrowers– 45% report smaller loan sizes
• 64% report reductions in cash flow multiples
• 45% report declines in standard advance rates on collateral
• Industry Challenges Continue– Increases in delinquency rates (nearly
half report an increase)– Increases in charge-off rates (nearly half
report an increase)– 80% report the number of loans being
made by competitor banks declined
Banks (Senior Lenders) Loan Type Declined % Offer % Book to Offer %Cash flow 67.3% 31.7% 58.6%Collateral 63.3% 36.7% 60.4%Real estate 60.3% 39.0% 75.6%
9.2%
20.3%
16.5%
14.2%
8.2%1.6%
3.4%
3.0%
12.8%9.1%1.7%
Reasons for Declined LoansQuality of EarningsQuality of Cash FlowSize of CompanyDebt LoadInsufficient CollateralInsufficient CreditAvail of Pers. GuaranteesInsufficient Operating HistoryInsufficient Management TeamWeakening Industry Economic concernsOther
• Motivations for Loans– Refinancing at 40.2% (44%
previously)– Acquisitions at 17.1% (7%
previously)– Growth at 9.8% (12% previously)
• Important Factors when Lending– Collateral at 14.8% (7% previously)– Liquidity (14.1%)– Debt to cash flow (12.2%)– Fixed charge coverage (12.1%)
Banks (Continued)
40.2%
2.6%9.8%1.1%
17.1%0.5%
14.5%
12.8%
1.2% RefinancingManagement buy-outFinancing growthChapter 11 workoutAcquisition loanDebtor-in-possessionWorking capital fluctuationsEquipment or buildingOther
Financial Ratio 1st Quartile Median 3rd
Quartile
Fixed charge coverage 1.2 1.3 1.3
Funded debt to EBITDA 2.5 3.0 3.5
Total debt to EBITDA 3.0 3.5 4.0
Debt to tangible net worth 2.2 3.0 4.0
• Restrictive Credit Environment– 82% report increases in loan
applications– 73% report lower percentage of
borrowers approved for credit
• Industry Concerns Linger– Increases in delinquency rates– Increases in charge-off rates– Declines in the number of loans
being made by competitor banks
Asset Based Lenders Declined % Offer % Book to offer %
Receivables 69.4% 30.6% 41.9%Inventory 74.5% 25.5% 50.9%Equipment 70.7% 29.3% 54.4%Real Estate 68.6% 31.4% 47.3%
14%10%
6%
17%29%
2%0%1%2%
6%3% 10%
Reasons for Declined LoansQuality of EarningsQuality of Cash FlowSize of CompanyDebt LoadInsufficient CollateralInsufficient CreditSize/Avail of Pers GuaranteesInsufficient Operating HistoryInsufficient Management TeamWeakening Industry Economic concernsOther
• Motivations for Loans– Refinancing at 44.1% (53%
previously)– Growth at 20.2% (12%
previously)– Acquisitions at 10.4% (22%
previously)• Advance Rates
– Vary by collateral type and quality
– Highest for marketable securities and receivables
• All-in Rates Decline Significantly for Larger Loans: Working Capital
ABLs (Continued)
$0.5M $2.0M $5.0M $10.0M1st quartile 14.8% 13.3% 7.5% 5.0%Median 17.5% 14.5% 10.5% 7.0%3rd quartile 20.3% 15.0% 12.8% 12.0%
Collateral Type 1st quartile Median 3rd quartileMarketable securities 80.0% 80.0% 90.0%Accounts Receivable 80.0% 85.0% 85.0%Inventory - Low 20.0% 25.0% 30.0%Inventory - Intermediate 30.0% 40.0% 47.5%Inventory - High 40.0% 50.0% 60.0%Equipment 50.0% 50.0% 75.0%Real estate 35.0% 50.0% 60.0%
44.1%
5.1%
20.2%2.3%
10.4%
3.2%
9.6% 4.9%0.4% Refinancing
Management buy-outFinancing growthChapter 11 workoutAcquisition loanDebtor in possessionWorking capital fluctuationsEquipment or buildingOther
• Signs of Growth– Nearly 78% report increases in business plans
received– Slight net increase in number of investments
being made– 54% of respondents report growth in the size of
industry– 48% report increases in warrant coverage
• Risk Aversion– Nearly 52% report a decrease in cash flow
multiples– 56% indicate a decreased appetite for risk– 48% report an increase in interest rate spreads– Net increase in tightness of financial covenants
• Motivations for Loans– Refinancing at 31.6% (33% previously)– MBOs at 24.6% (21% previously)– Growth at 20.6% (22% previously)
Mezzanine Funds
31.6%
24.6%20.6%
1.4%
16.8%3.3% 1.8%
RefinancingManagement buy-outFinancing growthChapter 11 workoutAcquisition loanDividend recapOther
Increased Decreased SameNo. of Business Plans Rec'd
77.8% 14.8% 7.4%
No. of Investments Being Made
48.1% 33.3% 18.5%
Size of Mezzanine Industry
54.2% 16.7% 29.2%
Warrant Coverage 48.1% 11.1% 40.7%Multiple of Cash Flow
18.5% 51.9% 29.6%
Appetite for Risk 22.2% 55.6% 22.2%Interest Rate Spreads
48.1% 22.2% 29.6%
Tightness of Financial Covenants
25.9% 0.0% 74.1%
• Financial Ratios– A typical firm will invest up to 4X EBITDA
(3.75X previously)– Up to 2.5X can be senior debt (unchanged)– Minimum fixed charge ratios are 1.1X (1.2X
previously)• Pricing
– Median coupon rate of 14% (previously 13%)
– Nearly 58% with PIK provision– 65% of deals with warrants (4-8% of diluted
ownership)– Expect 8% return on warrants
• Targeting Service and Manufacturing Over Next 12 Months
Mezzanine (Continued) Ratio Classification MedianFixed charge coverage Typical borrower 1.25 Absolute min 1.10Senior debt to EBITDA Typical borrower 2.00 Absolute max 2.50Total debt to EBITDA Typical borrower 3.50 Absolute max 4.00
Coupon Interest Rate13.0% 1st quartile14.0% Median15.0% 3rd quartile
34.0%
24.9%
1.8%1.8%
12.5%
5.0%0.1%
12.5%7.2%
ServiceManufacturingRetailWholesaleDistributionOil & GasRestaurantHealthcareOther*
• Challenging Investing Environment– 53% report a decline in leverage multiples– 62% report a decline in deal multiples– 68% report a longer time to exit deals– 70% report a decline in the size of industry
• Interesting Minority Interests– Nearly 70% of respondents report willingness to
invest in minority interests with investor protections
– Median discount from pro rata is 20%• Deal Flow Funnel
– 100 plans reviewed (up from 80)– 15 meetings– 5 term sheets– 2 letters of intent
Private EquityIncreased Decreased Same
Leverage (multiple)
17.7% 53.2% 29.0%
Deal multiples 11.7% 61.7% 26.7%Time to exit deals 68.3% 1.6% 30.2%Size of private equity industry
3.2% 69.8% 27.0%
Discount from pro rata (%)10.0% 1st quartile20.0% Median25.0% 3rd quartile
Plans Received
Meetings with
Principals
Term Sheets Issued
LOIs Signed
1st quartile 50 10 3 1Median 100 15 5 23rd quartile 200 30 10 3
• Exit Plans for Portfolio Companies– 43% report plans to sell to a public company (up
from 35%)– 30% plan to sell to another PEG (34% previously)– 7% IPO (previously 9%)
• Service and Manufacturing Industries Targeted Over Next 12 Months– Service at 30.7% (up from 27.3%)– Manufacturing at 23.8% (up from 21.3%)– Retail down to 0.8% from 4.1%
Private Equity (Continued)7%
29%
43%
1%
18% IPO
Sell to another PEG
Sell to a Public Co
Sell to a Hedge Fund
Other
30.7%
23.8%
1.4%0.8%
5.4%
8.5%0.9%
4.5%
10.8%
13.3% Service
ManufacturingRetailWholesaleDistributionOil & GasRestaurantReal EstateHealthcareOther
• Contraction Continues...– 59% report a decline in percent of plans funded
while 66% report decreasing percentages of “up” rounds
– 61% report an increase in time to exit– 73% report a decrease in appetite for risk– 61% believe fundraising prospects have declined– 91% report a contraction in size of industry
• Yet Hope Remains– Nearly 48% report increases in number of
business plans received– Approximately 46% report an increase in number
of high-quality investment prospects– 45.5% report increases in quality of portfolio
• Review 100 Business Plans to Close a Deal
Venture CapitalIncreased Decreased Same
Percent of Biz Plans Funded
4.5% 59.1% 36.4%
Percentage of "up" rounds
11.4% 65.9% 22.7%
Expected exit time
61.4% 9.1% 29.5%
Appetite for risk
6.8% 72.7% 20.5%
Fundraising prospects
14.0% 60.5% 25.6%
Size of venture capital industry
4.5% 90.9% 4.5%
Plans received 47.7% 22.7% 29.5%High quality prospects
45.5% 25.0% 29.5%
Quality of portfolio
45.5% 25.0% 29.5%
Plans Received
Meetings with
Principals
Term Sheets Issued
LOIs Signed
1st quartile 50 10 2 1
Median 100 20 2 13rd quartile 100 27.5 3 1.6
• Higher Expected Sales to TVI Ratios for New Investments Made in Last 6 Months– Stage 1 increased from 8.2X to 9.5X– Stage 3 from 6.4X to 8.5X– Stage 6 rose from 3.9X to 5.5X
• Longer Expected Time to Exit for New Investments Made in Last 6 Months– Stage 1 from 6.2 years to 7.5 years– Stage 3 from 5.1 years to 6.5 years– Stage 6 from 3.8 years to 3.5 years (shorter)
• Implied Returns on Investment Lower– Stage 1 from 40.5% to 35.8%– Stage 3 from 43.5% to 41.4%– Stage 6 from 43.3% to 43.0%
• Exit Plans– Sell to public company is 58.9% (previously
50%)– Sell to private company is 21.6% (previously
24%)– IPO is 12.4% (down from 17%)
Venture Capital (Continued)
12.4%1.0%
58.9%
21.6%
5.8% 0.2% IPOSell to another VCSell to a Public CoSell to a Private CoSell to a Hedge FundSell to Private EqOther
Sales/TVI Stage1
Stage2
Stage3
Stage4
Stage5 Stage6
1st Quartile 7.5 6.5 5.5 3.5 3.5 3.5Median 9.5 9.5 8.5 7.5 5.5 5.53rd Quartile 21.5 15.5 9.5 9.5 7.5 6.5
Returns Stage 1 Stage 2 Stage 3 Stage4 Stage 5 Stage6
1st Quartile 26.7% 26.7% 25.6% 30.0% 24.7% 19.6%Median 35.8% 35.0% 41.4% 36.3% 39.7% 43.0%3rd Quartile 53.6% 40.3% 50.6% 50.6% 46.1% 64.5%
Exit Time Stage1
Stage2
Stage3
Stage4
Stage5
Stage6
1st Quartile 6.25 5.5 5.5 4.5 3.5 2.5Median 7.5 6.5 6.5 5.5 4.5 3.53rd Quartile 8.75 8.5 7.5 6.5 6.5 6.5
• California is Target for Nearly 36% of Investments over Next 12 Months– Nearly 10.7% outside of U.S.– 5.7% in Texas– Massachusetts decline from 6.9% to
3.6%• Clean Technology is Industry
Targeted for Largest Concentration of New Investment over Next 12 Months– Increase from 12.3% to 14.5%– Software from 15.8% to 13.5%– Hardware from 6.7% to 3.2%– Biotech from 11.6% to 9.8%
Venture Capital (Continued)20.9%
13.0%
1.7%
3.6%5.7
%0.9%1.0%3.2%3.1%
8.2%1.4%
2.6%
10.7%
24.1% Northern CASouthern CACA (Other)MA TXWA StateD.C. Metro AreaNY Metro AreaNew EnglandSoutheastPhilly Metro AreaCOOutside U.S.Other*
1.8% 9.8%12.2%
2.3%
13.5%
3.2%1.8%
14.5%
0.7%3.1%
8.1%1.0%0.2%
2.9%
7.1%
8.9%9.0%
NanoBiotechMed DevicesPharmaSoftwareHardwareEnergyClean techIndustrialMedia & EnterInternet SpecificCons ProductsFinancial SvcsBusiness SvcsHealthcare SvcsInfo TechOther
• Glass Half Empty or Half Full?– Despite nearly 50% indicating increased
competitive pressures, approximately 64% report that growth opportunities increased relative to 6 months ago
– However, nearly 46% report decreased access to capital
• Businesses Report Varied Costs of Capital, Paybacks, and Expected Returns
• Realistic, Optimistic, or Delusional?– Approximately 57% believe they qualify for a
bank loan– Nearly 47% believe they qualify for a private
equity investment– Almost 41% believe they qualify for venture
capital
Privately-Held Businesses
Investments Payback Cost of Capital
Expected Returns
New computer system
2.05 10% 20%
Hiring a sales person
1.52 20% 30%
Acquire a competitor
3.22 25% 30%
Expand current market niche
2.48 20% 25%
Enter new market niche
2.77 20% 25%
0.0%10.0%20.0%30.0%40.0%50.0%60.0%
56.9%
21.8%
47.1%
10.9%
40.8%
6.3% 10.3% 12.6%
Investment Analysis Techniques Frequency of Use in the Private Markets
Payback DCF IRR Option Analysis Simulation Analysis Market Analysis Multiple Analysis Gut Feel0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
57.0%
43.9%
76.4%
5.9%
31.7%
62.9%
91.1%
60.4%
Mezzanine Private Equity Venture Capital Private Businesses Average
12 Month OutlookBanks ABLs Mezz PE VC Business Average
Demand for Capital
Increase 66.7% 100.0% 74.0% 84.6% 70.5% 79.2%
Stay the same 25.0% 0.0% 22.0% 13.8% 25.0% 17.2%
Decrease 8.3% 0.0% 4.0% 1.5% 4.5% 3.7%
Capital Restrictiveness
Increase 8.3% 20.0% 4.0% 46.2% 47.7% 25.2%
Stay the same 50.0% 50.0% 74.0% 40.0% 45.5% 51.9%
Decrease 41.7% 30.0% 22.0% 13.8% 6.8% 22.9%
GDP
Overall 1.7% 1.4% 1.6% 1.0% 0.9% 0.5% 1.2%
Private Company 1.0% 1.5% 2.0% 2.1% 2.8% 1.1% 1.7%
Business conditions
Improve significantly 8.3% 10.0% 3.7% 1.5% 4.5% 16.7% 7.5%
Improve slightly 66.7% 50.0% 51.9% 61.5% 61.4% 45.4% 56.2%
Stay the same 25.0% 30.0% 33.0% 15.4% 22.7% 18.4% 24.1%
Decline slightly 0.0% 10.0% 11.1% 18.5% 4.5% 12.1% 9.4%
Decline significantly 0.0% 0.0% 0.0% 3.1% 6.8% 7.5% 2.9%
Returns to LPs (next 12 months) 15.0% 20.0% 12.0%
John K. PagliaAssociate Professor of FinanceSenior Researcher, Pepperdine Private Capital Markets Project
Bschool.pepperdine.edu/privatecapital
Thank You!