Small Deals Big Factor in Middle-Market Private Equity in 2024
GF Data's Bob Dunn examines the data on add-on investments from the past year
As middle-market private equity has focused more on smaller add-on investments over the last three quarters, GF Data decided to analyze a new size parameter—transactions valued between $1 million and $10 million.
Our analysis has traditionally focused on private equity-backed transactions valued between $10 million and $500 million. However, amid a challenging deal environment, we felt it necessary to expand our parameters to look at the very smallest deals in middle-market private equity.
We discovered that in the current environment, smaller deals—while obtaining lower valuations on average—tend to fare better as add-on investments in terms of both pricing and debt coverage than as platforms or stand-alone deals. What’s more, rollover equity played a significant role in valuations for businesses valued at less than $10 million through the first three quarters of last year.
When looking at all deals reported to GF Data in the first three quarters of 2024 valued between $1 million and $500 million, we found that nearly 48% of transactions tracked were add-on investments. This compares to 38% of the sample for contributed deals in 2023.
But when considering only deals valued between $1 million and $10 million through the first three quarters of last year, the ratio jumps to nearly 90% in favor of add-ons.
In the first three quarters of 2024, GF Data tracked 109 deals with total enterprise values (TEV) between $1 million and $10 million widened through the third quarter of last year, reaching nearly a full turn of EBITDA on average. This is a significant change from 2023, when deals valued below $10 million received slightly better valuations than the average at the next size level with TEV between $10 million and $25 million.
Deals valued between $1 million and $10 million traded at an average of 5.5x trailing 12-month (TTM) EBITDA through the first three quarters of 2024, compared to an average across all deals valued between $1 million and $500 million of 7.1x TTM EBITDA, and an average of 6.4x for transactions with TEV between $10 million and $25 million.
Valuations for add-on investments valued between $1 million and $10 million were significantly higher for platforms through the first three quarters—following a trend for deals valued between $10 million and $50 million over the same period, but out of step with conventional wisdom.
Deal activity—or lack thereof—is one component driving the inversion. As noted, middle-market private equity firms have pursued fewer platform investments since the latter part of 2023 as debt markets became more challenging and available debt coverage for platform deals dropped. This prompted more private equity groups to shop for add-ons—while using existing revolving credit facilities to finance these deals.
These investing trends created an environment through the first three quarters of 2023 where add-on investments with TEV between $1 million and $10 million averaged 5.7x EBITDA while platforms averaged just 4.5x.
In addition to increased demand for add-ons from potential acquirers, the difference in debt coverage availability between platforms and add-ons in this size range also drove the pricing disparity.
In the first three quarters of 2024, total debt coverage on reported transactions valued between $1 million and $10 million reached an average of 5.4x, while senior debt coverage averaged 4.4x—significantly above the 2023 average for the same size tier (3.7x and 3.5x, respectively), and well above the three-quarter average for all deals valued between $1 million and $500 million (4.0x and 3.3x, respectively).
When looking across all deals in the $1 million to $10 million TEV range, the average across the first three quarters of 2024 was financed with 66.7% senior debt—based off the profile of the acquiring entity—while equity contribution was just 19.6%. Subordinated debt covered the remaining 13.7% on average. This compares to an average breakdown of 55.4% senior debt, 40.7% equity and 3.8% subordinated debt for the same TEV category in 2023.
When only platforms are considered across the first three quarters of 2024, the capital stack shifts in the other direction, with sponsors contributing 61.4% of the purchase price in equity, with 6.8% of the total on average coming from subordinated debt, and senior debt averaging just 31.8%.
Rollover equity was also a significant factor in business valuations for deals valued between $1 million and $10 million through the first three quarters of last year. Deals that included rollover equity recorded an average purchase price of 6x TTM EBITDA compared to an average of 4.3x for those deals that did not include rollover equity. Rollover equity contribution reached 12.7% of TEV (compared to an overall average of 14.5% for all deals tracked by GF Data), and the incidence of rollover equity was 28.6% through the first three quarters of 2024.
Finally, in addition to a tough lending market and a challenging environment to launch new platforms, multiple arbitrage no doubt has played a role in activity in smaller transactions. When comparing platform investments valued between $1 million and $10 million with deals valued between $10 million and $100 million through the first three quarters of last year, GF Data found a difference of 2x EBITDA—4.5x versus 6.5x, respectively—close to the 2.5x difference found between platforms valued between $10 million and $100 million and platforms valued between $100 million and $500 million—6.5x to 9x, respectively.
Bob Dunn is managing director of GF Data, an ACG company and the leading source of private deal valuations in the middle market.
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