Valuation Trends in the ARM Industry

Company valuations in the U.S. took a downward trend during the recession across most market segments, and the ARM industry was no exception. Buyers started having difficulty accessing debt financing during the financial meltdown of 2008.  As the recession deepened, sellers faced increased uncertainty in projecting future financial and liquidation performance. These influences caused acquisition multiples to drop and the amount of deal structure to increase from mid-2008 through last year.

Acquisition multiples and debt multiples tend to mirror each other, so as the debt multiples rose from 2004 through 2007, so too did the acquisition multiples -- particularly from private equity buyers. Similarly, we saw a clear correlation between levels of debt financing and lower valuations in 2008. 

During the credit crunch, lenders became more conservative, raising their underwriting standards and pulling back from M&A activity because of challenging economic conditions and poor corporate performance results.  With limited access to debt financing, buyers began to lower their offer prices or incorporate deal structure – such as earn outs, seller’s notes, and equity – to bridge their valuation gap and share the deal risk with the seller.

ARM companies generating less than $5M in annual revenues did not experience much of a decline in market valuation during the recession; however we did see an uptick in distressed situations within this category.  Buyers of these businesses had less access to small business loans, because lenders were concerned about the buyer’s ability to sustain existing financial performance post-transaction.  As you can see in the chart below, this resulted in a slight increase in the number of completed transactions that included some form of structure. Sellers in this category accepted deal structure particularly in the form of a seller’s note.

Changes in Multiples and Deal Structure Pre- and Post-Recession

Owners of mid-sized ($5M to $20M in annual revenues) and large ARM companies (over $20M in annual revenues) saw the greatest change in market valuations – especially for companies with over $20M in revenue. The transactions that met, or in rare cases exceeded, the higher end of these ranges typically involved a greater percentage of deal structure than those at the lower end of the ranges. For mid-sized and large ARM companies, deal structure helped buyers to protect their downside risk while meeting the market valuation expectations of the sellers.

As an example, we represented a large ARM company last year which was performing well despite the recessionary market conditions. Unfortunately, in the middle of our process the lending multiples dropped and as a result the buyers were not able to sustain their original offers. We had to revise the terms between our client and the buyer.  They both agreed to a higher enterprise value that incorporated more deal structure in the form of earn-outs and seller’s notes. This company has since continued to meet or exceed its financial projections and as a result of the deal structure, it is better positioned financially to achieve future growth.

Clearly these changes in market value caused a decline in overall M&A activity, but they also enabled strategic and industry buyers to become more competitive in the M&A process. This became a benefit to certain sellers who were interested in selling 100 percent of their ownership stake and not having to retain equity post-transaction.

The good news is that as lending multiples began to increase in the second half of 2009, as the financial markets showed improvement and there were strong signs of the economy exiting the recession. So far this year, the lending multiples have sustained their levels from Q4 of last year and we are seeing increased interest from both strategic and financial buyers to pursue acquisition opportunities.

Michael Lamm advises owners on their growth and exit strategies for Kaulkin Ginsberg’s Strategic Advisory team. Michael can be reached directly at 240-499-3808, by email, or through his social networking page on insideARM.com.