Paglia am&aa launchpad keynote final 6.09.2011

The State of the Private Capital Markets

Private Capital Markets LaunchPadJune 10, 2011John K. Paglia, Ph.D., CFA, CPA

Associate Professor of FinanceSenior Researcher, Pepperdine Private Capital

Markets Project

• What is cost of capital for privately-held businesses?

• The project launched in 2007; first report in July 2009

• We now survey 12 segments semi-annually

• Survey asks about firm profile, behavior, returns, view of next 12 months

• Certificate in Private Capital Markets offered again in Malibu November 14-16

Pepperdine Private Capital Markets Project

What is the Status of Privately-Held Businesses

as of Spring 2011?

Prob. of failure finally declines

Net income expectations

positive

Confidence rebounds sharply

Optimistic about growth

What are Owners Focusing on Today?

Finally ended layoffs and CAPEX reductions

Still increasing collection

times

Pricing power or inflationary

response?

More competitive than ever

Business Owner Access to Capital

(Net Increases)

Finally reversed deteriorating capital access

• Nearly 95% of business owners report having the enthusiasm to execute growth strategies

• Yet just 53% report having the necessary financial resources to successfully execute growth strategies

What is the State of Financing?

• How much senior leverage is available for transactions?

• How much junior leverage is available and what are the total debt thresholds?

• How much equity is available for growth capital and transactions?

Capital Access Drives Valuations and Deal Flow in the Middle Markets

What’s Happening with Capital Providers?

• 37% of activity from refinancing; 17% acquisitions; 12% growth financing

• 60% of applications declined, 36% lack high-quality earnings/cash flow

• Demand for loans up, due diligence efforts increased significantly

• Leverage increased slightly

What’s Happening in Banks?

• Personal guarantees mandatory under $15 million EBITDA

• Regulatory pressure to avoid risky loans increased, 76% report feeling increased pressure

• 60% indicate that increased pressure led to declining loans that otherwise would have been made

What’s Happening in Banks? (Cont’d)

• 26% of investments next year in business services, 25% manufacturing, 14% wholesale and distribution

• Demand for investment up considerably along with leverage and deal multiples

• Confidence and conditions improving

• Warrant coverage and expected returns down slightly

What’s Happening in Mezz?

Tightness of Financial Covenants, Warrant Coverage and PIK Features

Warrant coverage declines

Covenants less restrictive

• 25% of investments in next 12 months in manufacturing, 14% in business services, 14% healthcare

• Demand for investment up considerably along with leverage and deal multiples

• Confidence and conditions improving

What’s Happening in PE?

• Power of LPs increasing! 30% say beneficial; 38% say detrimental

• 56% now looking at larger/smaller investments to deploy capital

• Making more minority investments; 60% indicate no change in expected returns

What’s Happening in PE? (cont’d)

What are Investment Bankers Experiencing?

• Deal flow has increased slightly

• Leverage multiples have improved slightly, as have deal multiples, particularly for later-stage companies

• Due diligence efforts by banks and buyers have increased

Compared to Six Months Ago

40% of Business Sale Engagements Expired Without a Transaction

Valuation Gaps for Non-Transacted Engagements

Difficulty Securing Senior Debt?

Balance of Capital with Businesses Worthy of Financing: Surplus or Shortage?

Top Issues Facing Privately Held Businesses (Today versus Emerging)

Today

Emerging

John K. Paglia, Ph.D., CFA, CPA

Associate Professor of Finance

Senior Researcher, Pepperdine Private Capital Markets Project

bschool.pepperdine.edu/privatecapital

john.paglia@pepperdine.edu

Thank You!