Forvis Mazars’ CFO Roundtable Explores the State of the Market

Twenty attendees participated in the roundtable, which was held at the Cherokee Town and Country Club.  

Here are some of the insights shared by Parker, Linch and Dunn, lightly edited and condensed for print.  

Contextualizing the Market

Bob Dunn: If you look at 2023, it was a disappointing year compared to 2022 and especially 2021. At GF Data, we tracked 72 deals in the first quarter of 2024, compared to 291 deals for all of 2023; 333 deals for 2022; and 501 deals for 2021.  

But the context is important: 2021 was an outlier. It was the product of a realization that business wasn’t going to grind to a halt with COVID, and that you could do virtual site visits and handle things on Zoom. In general, 330-350 deals annually on average is more typical.  

So, 2023 was off by 47% compared to 2021, and we’re about 17% off from where the market would normally be. Higher interest rates obviously factored into that. I also think it’s easy to forget, but in 2023, we had the second largest banking failure in U.S. history. That seems like a long time ago now, but obviously it’s reverberating in terms of what we’re paying for debt.  

The other point to note is a marked step-down in average valuations from 2022 through 2023: about three-tenths of a turn of trailing 12-month EBITDA. Then in the first quarter of 2024, there was an even larger drop, of a little more than half a turn of EBITDA. 

I view this as a positive for the market. I said to one of our family office contributors at the end of the fourth quarter, “We’ve really had a deal flow problem in the last year.” And he said, “No, we’ve had a deal valuation problem, because we can’t agree on the value. Sellers still think it’s 2021, and it’s not 2021 anymore.”  

COVID was an atypical period, so what are you using for comparison’s sake? Is the earnings growth that a lot of industries experienced during COVID sustainable? I would venture that it isn’t, and we’re seeing a lot of dented companies coming through with declining revenue. But I think that’s a positive, and there are signs in the market of acceptance that prices need to come down. 

There needs to be bridging mechanisms, which have been another big feature of the last year or so. Earnouts, seller rollover equity—anything that helps to align interests.  

I don’t think any seller likes rollover equity or earnouts, but there’s a desire to have alignment of interest on the part of the buyer. And if the seller believes that growth is sustainable, then the buyer is asking that they put their money where their mouth is. About 60% of transactions in the last five quarters included an earnout, which is atypical, but it’s very much part of the landscape now. 

Small Deals Loom Large

Dunn: Most of 2023 was a flight to quality, and a flight up-market in terms of enterprise value. That’s starting to slip away a little bit. Now there’s more pressure on the larger companies in terms of debt financing, but it’s improving for the smaller ones—the smaller companies encountered the challenges earlier. The larger ones are now starting to see challenges on pricing. I think this is all part of the market digesting the fact that it’s a different time than it was two years ago.  

Scott Linch: What we’re seeing in deal flow right now is that smaller deals are where it’s at. The big mega deals aren’t happening as much. Those aren’t really flourishing right now, especially with interest rates going up. We are seeing a lot of middle-market deals. Interestingly, add-ons to companies right now account for 75% of all deal flow.  

Dunn: There’s been some interesting distortion on the price paid for platforms versus add-ons. Traditionally, you see add-ons going for much less than platforms, but now we’re seeing at least a couple of the size tiers in which add-ons are going for more.  

Traditionally, you see add-ons going for much less than platforms, but now we’re seeing at least a couple of the size tiers in which add-ons are going for more.  

Bob Dunn

GF Data

Part of this is larger firms going down-market to use existing credit facilities on their platforms to buy other companies, because they’re not liking the rates they’re getting or they can’t get the financing . So that is some of the distortion you still see: 7.3x (total enterprise value (TEV)/EBITDA) average for platforms, versus 6.7x for add-ons. That’s less of a difference than we’d expect to see between the two. Moving down-market is a trend that we saw in 2023 and in the latter part of 2022, which means that some of the add-ons are going for higher multiples than platforms, because these bigger players are involved.  

Public v. Private

Billy Parker: The stock market is at an all-time high, including NASDAQ. I know it ebbs and flows, but what are you seeing as far as the correlation between the stock market and private company values? 

Linch: Ultimately, the public markets have multiples of earnings, too, so those will drive these multiples to some extent. But private companies are often discounted; the liquidity is different than in the stock market. You have some private company discounts and things going on. 

Dunn: While there was an impact on lending in the middle market, you haven’t had the challenges of syndication last year, which made it worse to be a larger public company at that time than a smaller private company. 

Linch: Most people will have been relying on private credit, versus senior debt, to get deals done, and now it’s starting to shift a little bit. The senior debt usage is picking up.   

Continuation Funds

Dunn: We’re in an era where continuation funds are becoming a real factor. A continuation fund allows a private equity sponsor to essentially sell the interest that the LP has and return the money but retain the ownership of the company. It’s always been a fringe thing, but we’re seeing a lot more activity there. 

Linch: By way of background: Continuation funds are an option for private equity firms when they want to sell a company but it’s not good time to sell. The LPs want liquidity, so they want their money back. The private equity firm raises a fund that basically buys the company so that the GP can keep their interest in the company while also giving LPs their money back.  

The biggest deal that just happened with that was the SRS Distribution deal, which was sold to Home Depot in a huge exit for Leonard Green. But the reason why Leonard Green was able to hold that asset for longer is because they raised a continuation fund.  

Parker: A cool thing about continuation funds if you’re an investor is, instead of having a seven- or eight-year horizon, you maybe have a three-year horizon. Therefore, you can have liquidity, even though you’re in private equity. They’re pretty cool products, which makes it even more propelling in the industry. I think we’ll see more use of continuation funds. 

Linch: And most of the LPs don’t roll over. They’re given the first right to stay in the continuation fund and stay in the company, but most don’t because they really need to get liquidity back. 

Parker: It works out great for the investor. If you have liquidity, you can get out, which  is rare, and it propels the whole industry of private equity. People can say, “OK, I’ll get in if I can get out in two years or one year,” as opposed to having a five-year minimum and a 2% gate. 

Linch: The bigger deals aren’t getting done right now because interest rates have gone up, and so the hold periods are a lot longer. Normally, you’re supposed to sell your business in five years for private equity. Now you may have to hold it seven or eight, and to get to that seven or eight, you have to give liquidity back by five. It’s not that the businesses aren’t performing necessarily, it’s that the market’s not good right now to sell them.