The Venture Capital & Private Equity spaces have both faced a bit of a conundrum in 2016 and 2017: dry powder ready for investment is at all time highs, but the number of deals closing has been dropping. Interestingly the lower number of deals hasn’t necessarily led to fewer dollars being invested. Contrarily, the average size per deal has been increasing significantly, leading to aggregate deployed investment dollars at or above all-time highs for most stages of VC & PE investments.
This trend towards fewer deals at larger deal sizes has been spotted nearly uniformly across the diverse capital stages in 2017, from Seed to PE buy-out/M&A. However, it leads to a few challenges for both companies and investors in terms of getting deals done. First, the larger size of deals has created an increased interest in in-depth due diligence. Issues arising during due diligence has been cited as a greater cause of broken deals than in the past, and has also led to an increase in the time required for closing. The average PE deal in 2017 has taken 16 weeks from signing of the LOI to close, as opposed to the 12 week average seen in most of the last few years.[1] It’s our personal belief that the additional due diligence rigor is a good thing in the long term as it helps assure higher-quality deals are the ones who receive funding, but in the short term it has created delays in getting to closing, as well as headaches for company CEOs who are balancing long lists of due diligence requests from a variety of potential funders.
““The average PE deal in 2017 has taken 16 weeks from signing of the LOI to close, as opposed to the 12 week average seen in most of the last few years.””
Second, there has been an increase in competition for deals. In NRV’s experience, this is often “solved” via syndication, with multiple investors coming into a single financing round. In many respects this is a positive for both companies and investors as it can bring additional valuable investor talent to the deal as well as the boardroom. The added complexity of multiple funders is another contributor, however, of slower time to closing and can lead to sometimes unnecessary complexity in negotiating deal terms with CEOs across multiple funders.
Upward pressure on deal multiples – ie the price an investor is willing to pay compared to a common metric like Revenue or EBITDA – is a third area of challenge we’ve noted in today’s investing environment. Deal multiples in Q3 2017 hit unprecedented highs across the last 5 years, with median EV/EBITDA values hitting 10.0x, a significant uptick from medians closer to 6.0x-7.0x in 2012-2016. While multiples showed some signs of decreasing in Q4 2017, many expect multiples to remain high in 2018 as well.[2] This creates an excellent environment for companies ready to exit, but a more challenging one for finding reasonable-valuation opportunities to invest into.
Later stage PE investors reflect similar concerns to the ones we have observed, and when surveyed the PE investors indicated “High Transaction Multiples” as their #1 concern going into 2018, with “Deal Sourcing / Lack of Quality Assets” as #2 and “Competition” as a close third.[3]
The ultimate investing environment in 2018 is still open to many uncertainties around tax reform, regulatory unknowns, and IPO & exit trends, among others, but NRV is continuing to keep a focus internally around being “choosy” for companies with reasonable valuations, strong funding partners, and a clear strategy towards an exit. With ample dry powder held by down-stream, later-stage VC & PE funders, we see today’s environment as a uniquely opportunistic one to ensure our portfolio companies have strong opportunities to both raise capital towards achieving strategic milestones, as well as exit once those milestones are achieved.
[1] Pitchbook Data, Inc. “Global PE Deal Multiples Report: 2017.” 18 Dec 2017, https://my.pitchbook.com/reports.
[2] Ibid.
[3] Pitchbook Data, Inc. “2018 PE Crystal Ball Report.” 3 Jan 2018, https://my.pitchbook.com/reports.