Lower Middle Market Update

Economic Performance

In Q3 2023, the U.S. economy grew at a 5.2 percent annual rate, up from 2.1 percent in Q2. This was the strongest growth since Q4 2021. Consumer spending, the largest contributor to the increase in GDP, grew at an annualized 3.6 percent. The second largest contributor to GDP growth was private inventory investment, including wholesale trade, manufacturing, and retail trade.

In October, Small Business Optimism registered 90.7, near even with September’s reading of 90.8 and remaining below the 49-year average of 98. The decline reflects persistent inflation concerns and a negative outlook for future business conditions. Labor challenges remain significant, with 43% of owners struggling to fill job openings. To address these challenges, business owners noted plans to raise compensation.

In Q3 2023, the CFO Survey's average optimism rating for the U.S. economy was 56.2 out of 100, slightly up from Q2. Approximately 40% of CFOs are cutting back on spending amid indicated heightened concerns around monetary policy, labor quality, and weak demand. Looking ahead, CFOs anticipated an improved 2024, expecting revenue growth of over 6% and nearly 4% employment growth.

Sources: U.S. BEA, BLS, The University of Michigan's Index of Consumer Sentiment, S&P Global, NFIB, The CFO Survey

M&A Data

In Q3 2023, deal volume continued to decrease with just 56 transactions. This slowdown is likely due to market uncertainty and the sustained high cost of debt, prompting sellers to delay deals until conditions improve and buyers to wait for clearer signs of stable performance.



In Q3 2023, there was a significant recovery in valuation multiples. Average valuations of completed deals rose to 7.5x TEV/EBITDA, a notable increase of 0.8x from the previous quarter. This rebound aligns with the first quarter’s 7.6x TEV/EBITDA, bringing the year-to-date average to 7.3x. In the quarter, the valuation spread between average and above-average performers widened, suggesting buyers are paying larger premiums for quality businesses.

For deals between $10mm - $25mm, valuation multiples have contracted sharply through Q3 2023, falling to 5.8x from 6.5x in 2022. However, debt utilization remained largely unchanged from 2022, indicating that there is still lender confidence in fixed-cost coverage. 



For deals between $25mm - $50mm, valuation multiples through Q3 2023 increased slightly, largely driven by increases in Q1 2023 and normalizations around 7.0x in Q2 and Q3. Unlike the deals in the smaller valuation bucket, there was a meaningful decline in debt utilization. Specifically, senior debt declined from 3.0x in 2022 to 2.5x in through Q3 2023, while subordinated debt was essentially unchanged at 0.8x.

For deals between $50mm - $100mm, valuation multiples fell slightly from 8.5x in 2022 to 8.2x through Q3 2023, offset by valuation increases in the third quarter. Like the $25mm-$50mm bucket, senior debt declined from 3.4x in 2022 to 2.9x through Q3 2023 while subordinated debt increased slightly to 0.8x from 0.6x through Q3 2023.  

Cost of Debt

In Q3 2023, the average 90-Day SOFR rate increased to 5.1 percent, up 30 basis points from 4.8 percent in the second quarter. Meanwhile, the average Senior Debt spread rose to 5.2 percent, a 70 basis points increase from the previous quarter, indicating high uncertainty from senior lenders around business and macroeconomic performance. 

Subordinated Debt coupons also increased, reaching 12.0 percent, up from Q2 but in line with Q1. The increase in subordinated debt pricing likely reflects an increase in perceived risk from subordinated lenders in the face of economic uncertainty and subordinated debt comprising an increased portion of total debt.

The FOMC's actions earlier in the year appear to have set the stage for these elevated rates, reflecting a trend of tightening financial conditions.

ABOUT US

Whether you want to sell or buy a business, Chapman Associates provides a personalized service based on our sixty-nine years of successful M&A closings and our relationships with more than 9,600 registered buyers.

Chapman is one of the most respected middle-market M&A firms in the country. What makes Chapman different from the competition?



• We make a market for our clients.

• We do not charge any up-front fees.

• Our fees are based on completed transactions.

• We devote senior-level attention to every M&A transaction.

• We do not delegate work to junior staff.

• We help clients set realistic goals and work hard to exceed them.

• We conduct in-depth research and rigorous analysis.

• We prepare all necessary offering materials.

• We have ten offices nationwide to serve our clients.

Mark Mroczkowski, CPA, CM&AA

Managing Director 

mark@chapman-usa.com

www.chapman-usa.com

407.580.5317