Perspectives:

Planes Landing Dont Make the News

Apparently Neither Does a Steady Lower Middle Market
Brett Palmer, President, Small Business Investor Alliance

The 2016 elections are rapidly approaching, which the What is the Lower Middle Market?
manufacturers of Tums and Rolaids could have told us by The lower middle market is a subset of the
their sales without looking at the calendar. The national US economy that represents small to
dyspepsia around this election is palpable, but is it all political medium sized businesses. For purposes of
or is it economic too? this newsletter, we define the lower middle
market as:
National news media have obsessed about the Presidential
Businesses that earn between $10mm
candidates emails, spouses, name calling, and all sorts of
unpleasantries. However, there has been nearly no and $100mm in annual revenues
meaningful discussion on the state of the economy and trivial Deals for businesses with between
discussion of the candidates proposals for tax and regulatory $10mm and $100mm in total enterprise
policies. While the name calling and soap opera drama might value
help ratings, it has done nothing help you or your portfolio Private Equity Funds that raise up to
companies know what to expect from the government that $500mm in capital
regulates and taxes them.

While the candidates have ignored the lower and middle market, that has not harmed our part of the market
one bit. The lower middle market is simply chugging along. These are not the best of times or the worst of
times. Deals are getting done. Companies are growing, albeit slower than normal. Pricing is stable and
companies are generally not over levered. NAV for many BDCs is rising. Private equity funds are able to raise
new funds. SBICs have record low costs of leverage. Good news is not newsworthy.

Steady as She Goes Revenue growth in the lower middle market continues to significantly outpace the S&P
500 with a far less volatility running at an average of 6.2% over the past 12 months. Employment growth in
this sector continues to run at over 3% - about 50% faster growth than large corporations.

Slow and Steady Wins the Race While faster revenue growth could be better, the portfolio companies in the
lower middle market are increasingly optimistic. Consistent revenue and employment growth is not only what
we have experienced for the past several years, but it is what executives are expecting for the future.

Keep Calm and Source On Aside from the Q4 2014 fiscal cliff driven deal frenzy which represented a
spike in multiples and volume, activity and pricing have been in a relatively stable band since the second half of
2013. Fund managers are seeing lots of deals and are able to be very picky about quality.

These indicators tell us where we have been, but not where we are going. However, GF Datas commentary on
Page 4 provides some further insights into how some of the data points might be early indicators of changes in
the market.

As you have seen several times over the past decade, policymakers affect our part of the market. You can be
sure that with a new President there will be nearly 100% turnover in the appointed leadership that affects the
economy (Treasury, SEC, SBA, etc.). Who will fill those seats is yet to be determined, but you can expect a
more populist approach finance and private equity is not popular. You can expect that banks will continue to
be hammered by hostile regulators regardless of who wins. Despite the inattention given to the economy, we
would be remiss to believe that the impending shakeup in Washington will not have an impact on the economic
landscape. However, the lower middle markets consistency through previous storms and foundation built on
value creation ought to neutralize some of the heartburn we have been experiencing in 2016.

Small Business Investor Alliance | Lower Middle Market Investment Insights | Volume 3, Issue 2 | 2016 Small Business Investor Alliance, all rights reserved.
 Lower Middle Market Business Indicators
The National Center for the Middle Market (NCMM) conducts a quarterly survey of middle market businesses and provides us
with data for lower middle market companies with $10 100 million in annual revenues. The data and our commentary below
indicates how these businesses compare to larger firms on standard metrics like revenue and employment growth. We also
feature the SBIA/NCMM Lower Middle Market Business Confidence Index, which combines revenue and employment growth in
the preceding year, and expectations for revenue and employment growth in the following year.

Revenue Growth (Last Twelve Months) Employment Growth (Last Twelve Months)
Lower Middle Market vs. S&P 500 Lower Middle Market vs. Large Corp. (ADP)
10.0% 6.0%
8.0%
6.0% 5.0%
4.0%
2.0% 4.0%
0.0%
-2.0% 3.0%
-4.0%
-6.0%
2.0%
-8.0%
-10.0%
1.0%
1Q12
2Q12
3Q12
4Q12
1Q13
2Q13
3Q13
4Q13
1Q14
2Q14
3Q14
4Q14
1Q15
2Q15
3Q15
4Q15
1Q16
2Q16
2Q17E

2Q17E
1Q12
2Q12
3Q12
4Q12
1Q13
2Q13
3Q13
4Q13
1Q14
2Q14
3Q14
4Q14
1Q15
2Q15
3Q15
4Q15
1Q16
2Q16
Lower Middle Market S&P 500
Lower Middle Market Large Corp.
Source: National Center for the Middle Market
Source: National Center for the Middle Market, SBIA Estimates
The lower middle market has seen more stable and Employment growth is rebounding from a downward trend
consistent revenue growth than the S&P 500 over the last that started at the end of 2014, with the 18-month low of
four years. A huge drop in the S&P 500 revenue growth 2.7% remaining above 2012 levels. Projections indicate
in 4Q15 further contrasts the volatility of the iconic that the trend will take another downturn in 2H16, as the
financial market indicator against the stability of the lower contraction in the industry converges around the new
middle market. It is encouraging to note that the market normal.
pressures that caused the drop in S&P revenue growth
did not cause more than a small dent in the LMM metric.
Incremental Investment Allocation SBIA/NCMM Lower Middle Market Business Confidence
Where would an extra dollar be allocated? Companies with Revenues between $10-100mm
120
62% 13%

65% 10%
64% 8%

66% 8%
58% 10%

67% 9%
58% 12%

64% 12%

62% 10%
62% 9%

61% 9%

61% 8%
66% 8%
56% 10%

118
116
114
112
110
108
106
104
29%
28%

102
27%

27%

27%
26%
26%

25%
24%

24%
23%

22%

21%

21%

100
98
1Q132Q133Q134Q131Q142Q143Q144Q141Q152Q153Q154Q151Q162Q16
Hold Cash Reinvest in Business Acquisitions Other Confidence Index, 2Q12=100
Source: National Center for the Middle Market Source: SBIA Estimates and NCMM Survey
The past year has seen an appetite for acquisition that After hitting a peak in 4Q14, the Confidence Index1 had
decreased after 2014 remain at consistent levels. The bulk an overall downward trend in 2015, ending with a low not
of survey respondents are most interested in holding cash seen since 2012. However, the index has rebounded in
or reinvesting in their businesses. Between 1Q16 and 1H16, with lower middle market executives reporting an
2Q16, interest in holding cash made a big incremental almost 10% increase in those who predict that their
jump from 21% to 27%, likely a reaction to the domestic revenue will grow in the next year. Those executives also
markets sluggish results from 1Q16. reported a more optimistic outlook on their employment
levels over the next year.

Small Business Investor Alliance | Lower Middle Market Investment Insights | Volume 3, Issue 2 | 2016 Small Business Investor Alliance, all rights reserved.
 Lower Middle Market Deal Trends
Average Multiples and Deal Volume Within GF Datas universe of middle-market deal sponsors, the
slowdown in M&A activity has been neither as deep nor as
Deals between $10-250mm in Enterprise Value
prolonged as general industry reports would suggest.
7.0 160
6.9 After a quiet first quarter, completed deal volume perked up in 2Q.
140
6.8 Our 206 active contributors completed 58 deals meeting GF Datas
120 parameters -- $10-250 million TEV and TEV/Adjusted EBITDA
6.7
6.6 100 multiples of 3-15x. This is a marked pickup from 46 reported deals
6.5 80
in 1Q and comparable to 54 deals in 2Q of 2015.
6.4 60 The second report placed a number of market trends in sharp relief:
6.3
40 Valuations overall averaged 6.8x TTM Adjusted EBITDA, slightly
6.2
20 up from the prior two quarters but essentially in line with market
6.1
averages since 2014.
6.0 0
Quarter-to-quarter shifts in valuation over the past two and a half
years have not been material. In addition, the size premium
TEV/Adj. EBITDA (L) Number of Deals (R) the spread between valuations on $10-50 million and $50-250
million TEV transactions has been remarkably steady. The
spread of 2.2x (an average of 5.8x on the smaller deals and 8.1x
Valuation Multiples by Deal Size on the larger ones) in the first six months of 2016 is exactly in
Total Enterprise Value/EBITDA for all Industries line with the spread in 2014-15.
While the market has been relatively stable in equity values,
8.8 there has been more movement over time in debt levels. Total
8.3 debt to EBITDA averaged in the mid-threes for several years
before rising to 3.9x in 2015 and remaining at that level in the
7.8
year to date.
7.3 As we have discussed at length over the past year, debt loads
6.8 rising while deal pricing holds steady has meant a decline in
6.3 average equity contribution, from about 50 percent in 2013 to
about 44 percent in 2015 and 2016 1H. We continue to believe
5.8
that a material pullback in debt levels will result in a
5.3 retrenchment in equity values, rather than a return to elevated
4.8 equity share.
Average total debt dropped a tick to 3.8x in 2Q. While this alone
is not material, there have been several other subtle shifts which
$10-25mm
$25-50mm if the leveraged finance market does at long last pull back
$50-250mm will come to stand out as early portents.
Specifically, we are keeping a weather eye on: the return to
higher valuation on platform investments compared to add-ons,
See page 5 for more information on how to access the greater percentage of completed deals involving above
GF Datas full reports and searchable valuation average financial performers and reduced utilization of uni-
database. tranche financing .

Equity and Debt Contributions Smaller Equity and Debt Contributions Larger
Deals between $10-50mm in Enterprise Value Deals between $50-250mm in Enterprise Value
100% 100%
37.1%
33.9%

39.7%

39.7%

39.2%

40.4%

43.6%

36.9%

41.4%
34.5%

37.6%

42.9%

35.3%

38.9%

37.8%

45.3%

42.6%

42.9%

90% 90%
80% 80%
70% 70%
60% 60%
50% 50%
51.5%

50.9%
50.9%
51.2%

40%
47.6%
48.8%

47.2%

40%
46.8%

46.7%
47.3%

47.1%
46.5%

44.8%
43.8%
44.5%
44.3%

42.6%
41.4%

30% 30%
20% 20%
10% 10%
0% 0%
1H12 2H12 1H13 2H13 1H14 2H14 1H15 2H15 1H16 1H12 2H12 1H13 2H13 1H14 2H14 1H15 2H15 1H16
Equity Sub Debt Senior Debt Equity Sub Debt Senior Debt

Small Business Investor Alliance | Lower Middle Market Investment Insights | Volume 3, Issue 2 | 2016 Small Business Investor Alliance, all rights reserved.
 Disclaimers, Definitions, and Access to Data
Disclaimer
This newsletter is intended only for informational, educational, and research purposes, and should not be distributed or
disseminated for commercial purposes without the permission of the Small Business Investor Alliance (SBIA). The information,
facts, figures, data, and analysis included in this newsletter are believed to be accurate, reliable, and credible, however SBIA is
not liable for any inaccuracies or errors in the information contained within. The newsletter does not, nor could it, take into
account the needs, objectives, and financial situation of its subscribers and should not be considered as investment advice by
the recipient. SBIA retains ownership of the contents of this newsletter and reserves the right to alter or make changes to the
information retained within without notice to subscribers.
Definitions
1. The SBIA/NCMM Lower Middle Market Business Confidence Index is an equal-weighted index based on four survey
responses from the National Center for the Middle Markets Middle Market Indicator. The survey includes over 600 C-Suite
executives of companies with annual revenues between $10mm and $100mm. The contributions to the index are: Revenue
Growth, Employment Growth, Revenue Growth Expectations, and Employment Growth Expectations.

GF Data
To subscribe to GF Datas full reports and searchable valuation database, visit www.gfdataresources.com, or contact Bob
Wegbreit at bw@gfdataresources.com or (610) 616-4607.

National Center for the Middle Market

More information about the Quarterly Middle Market Indicator survey, Benchmarking tools, and the Center can be found on their
website: www.middlemarketcenter.org

Small Business Investor Alliance | Lower Middle Market Investment Insights | Volume 3, Issue 2 | 2016 Small Business Investor Alliance, all rights reserved.