April 17, 2023
Private Equity: Managing Valuation Gaps in a Tough Market
The macroeconomic headwinds that dealmakers faced in 2022 have carried over into this year, and the recent unpleasantness in the banking sector threatens to make deal financing terms even tighter. Not surprisingly, this environment has caused private equity firms to find ways to bridge valuation gaps in order to get deals done. According to this PitchBook article, those efforts have included on our old frenemy the earnout as well as increased use of seller notes.
The article cites the results of an upcoming SRS/Acquiom survey, which found that 21% of non-life sciences private deals in the US contained earnout provisions, up from 17% in 2021. In 23% of those deals, the parties agreed to use the more buyer-friendly EBITDA performance metric instead of the revenue metric favored by sellers – an increase from 16% during the prior year. This excerpt from the article addresses the increase in the use of seller paper:
Another structure appearing more frequently is the so-called seller note: a form of financing where the seller agrees to receive a portion of the acquisition proceeds as a series of debt payments. A seller note ranks below the senior debt provided by banks or nonbank lenders to fund the acquisition. While the note is a form of subordinated debt, and hence carries more risk, it typically carries a lower interest rate—in the range of 5% to 8%—than mezzanine debt, said Reed Van Gorden, managing director and the head of origination at Deerpath Capital, a lower-middle-market private debt firm.
The article points to Emerson Electric’s recent sale of a majority stake in its climate tech unit to Blackstone as an example of seller financing. That $14 billion deal includes a $2.25 billion seller note that pays interest at 5%.
– John Jenkins