1. John K. Paglia, Ph.D., CFA, CPA
The State of the Middle Markets Risk Management Association May 18, 2011
John K. Paglia, Ph.D., CFA, CPA
Associate Professor of Finance
Senior Researcher, Pepperdine Private Capital Markets Project

2. Pepperdine Private Capital Markets Project
What is cost of capital for privately-held businesses?
The project launched in 2007
We survey 12 segments
Survey asks about firm profile, behavior, returns, view of next 12 months
Capital providers surveyed semi-annually
Last report published in December
Next report to be released in May 2011

4. Business Owners

6. What are Owners Focusing on Today?

9. Motivation for CAPEX Planned Over Next 12 Months

11. What Motivates Business Owners to Open Businesses?
Motive 1 2 3 4 5
Rank
Opportunity to Build Value
39%
21%
13%
11%
16%
Control / Flexibility
20%
27%
26%
19% 8%
Opportunities for Growth
15%
31%
18%
Lifestyle
14%
25%
Family Opportunities
36%

12. Capital Access Drives Valuations
in the Middle Markets
How much senior leverage is available and how does one qualify?
How much junior leverage is available and how does one qualify?
How much equity capital is available and how does one qualify?
What happens if one doesn’t qualify?

14. State of Financing
Approximately 54% of those businesses attempting to raise capital in the last six months were unsuccessful
Of those that were successful, approximately 59% of them secured bank loans followed by 20% who secured friends and family financing
Just 13% raised funding from angels, venture capital and private equity combined

15. How Competitive is Access to Capital?
Banks denied approximately 60% of loan applications over last six months
Angel investors funded just one business plan of 25 reviewed
Venture capitalists funded just one business plan of 80 reviewed
Private equity funds invested in just one business plan out of approximately 150 reviewed

16. Businesses Need Capital
to Grow and Build Value
Expected increase in organic revenues over the next year is approximately 20%
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

17. What are Top Issues Facing Privately-Held Businesses Today According to I-Bankers?

19. Most Important Emerging Issues According to Business Owners

20. Overall Impressions of Capital Sources
Very un-favorable
Un-favorable
Slightly Un-favorable
Neutral
Slightly Favorable
Favorable
Very favorable
Score (-3 to 3)
Bank loan 6% 5%
11%
15%
34%
22%
1.48
Asset based lender 4% 9%
21%
20%
29%
1.08
Private equity fund
12%
24% 7%
0.51
Angel investor
13%
14%
23%
0.12
Venture capital fund
10%
17%
19% 2%
-0.07
Mezz Fund
35%
16%
-0.12
Friends and family
18%
-0.22
Factor
-0.48

21. Slightly In-expensive
Impressions of Costs of Capital Sources
Capital Source
Very in-expensive
In-expensive
Slightly In-expensive
Neutral
Slightly Expensive
Expensive
Very expensive
Score
(-3 to 3)
Venture capital 1% 0%
11%
36%
40%
2.32
Private equity 2%
12%
18%
41%
27%
2.14
Mezzanine
16%
23%
2.02
Factor 3%
14%
19%
31%
32%
2.01
Angel investor 5%
24%
35%
15%
1.62
Asset based lender 4% 8%
33%
26%
1.25
Bank
loan 6%
17% 9%
0.83
Friends and family
10%
29%
-0.62

22. Ranking of Capital Sources
Overall Rank
Cost Rank
(Low to High)
Benefits Rank
Average of Rankings
Bank loan 1 2
1.3
Asset based lender 3 5
3.3
Private equity fund 7
4.0
Angel investor 4
Friends and family 6
4.7
Venture capital fund 8
5.3
Mezzanine Fund
6.3
Factor
7.0

23. Business Transfer Intentions (Spring 2011)

24. Business Transfer Timing (Spring 2011)

25. Capital Providers

26. What’s Happening in Banks
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

27. What’s Happening in Banks (Cont’d)
Personal guarantees and collateral requirements mandatory under $15 million
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
60% of applications declined, 36% lack high-quality earnings/cash flow
Demand for loans up, due diligence efforts increased significantly
considerably along with leverage and deal multiples
Confidence and conditions improving

28. What’s Happening in Mezz
26% of investments in next 12 months in business services, 25% in manufacturing, 14% in 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

29. What’s Happening in PE
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

30. What’s Happening in PE (cont’d)
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

31. Investment Bankers

32. Private Business Sales Transactions Closed in Last 6 Months

33. Average Number of Months
to Close a Deal

34. Components of Closed Deals
Average Value
Seller Financing / Seller Note
54.80%
Contingent earnout
53.40%
Lowered multiple of EBITDA
54.20%
Lowered amount of equity sold
34.00%

35. Equity Invested to Close Deals (Financial Buyers)
Company Size
Average Value
$1 million EBITDA
52%
$5 million EBITDA
47%
$10 million EBITDA
$15 million EBITDA
43%
$25 million EBITDA
$50 million EBITDA
36%
$100 million EBITDA

36. Reasons for 40% of Business Sale Engagements not Transacting

37. Valuation Gaps for Non-Transacted Engagements

38. Deal Multiples by Financial Buyers
Industry
$1M EBITDA
$5M EBITDA
$10M EBITDA
$15M EBITDA
$25M EBITDA
$50M EBITDA
$100M EBITDA
Service
4.0
5.0
6.0
7.0
8.0
12.0
Mfg.
5.3
10.0
Retail
3.5
7.5
8.5
Wholesale
4.8
3.3
6.5
Distribution
4.3
4.5
Oil and Gas NA
Restaurant
3.0
Healthcare
6.8
Technology
9.0
10.5
Media and Entertainment
5.5
Average
4.4
5.2
5.9
6.4

39. Premiums by Strategics?

40. Difficulty Securing Senior Debt
Very difficult
Difficult
Somewhat Difficult
Neutral
Somewhat Easy
Easy
Very Easy
% Difficult
$1M EBITDA
41.3%
27.3%
19.8%
8.3%
2.5%
0.0%
0.8%
88.4%
$5M EBITDA
12.7%
14.4%
33.9%
23.7%
10.2%
1.7%
3.4%
61.0%
$10M EBITDA
6.6%
10.5%
15.8%
25.0%
27.6%
11.8%
2.6%
32.9%
$15M EBITDA
5.8%
19.2%
28.8%
1.9%
30.8%
$25M EBITDA
6.5%
4.3%
17.4%
21.7%
19.6%
8.7%
28.2%
$50M EBITDA
11.4%
5.7%
20.0%
28.6%
14.3%
22.8%
$100M+ EBITDA
12.9%
3.2%
25.8%
22.6%
16.1%

41. Balance of Capital with Opportunities
Companies worthy of financing GREATLY exceed capital available
Companies worthy of financing exceed capital available
General balance between companies worthy of financing and capital available
Capital available exceeds companies worthy of financing
Capital available GREATLY exceeds companies worthy of financing
Score
$1M EBITDA
28.6%
37.1%
20.0%
11.4%
2.9%
-0.8
$5M EBITDA
13.2%
30.9%
32.4%
17.6%
5.9%
-0.3
$10M EBITDA
5.7%
17.0%
39.6%
24.5%
0.2
$15M EBITDA
4.9%
22.0%
29.3%
31.7%
12.2%
$25M EBITDA
6.3%
15.6%
31.3%
18.8%
28.1%
0.5
$50M EBITDA
13.8%
10.3%
31.0%
0.6
$100M EBITDA
18.5%
11.1%
14.8%
22.2%
33.3%
0.4
> $100M EBITDA
48.1%
0.7

42. Top Issues Facing Privately Held Businesses (Today versus Emerging)

43. The Road Ahead Continued economic uncertainty
Inflation and competitive pressures
Increasing confidence in growth prospects
Increasing demand for capital and capital availability
Increasing deal multiples

44. Thank You!
John K. Paglia, Ph.D., CFA, CPA Associate Professor of Finance Senior Researcher, Pepperdine Private Capital Markets Project bschool.pepperdine.edu/privatecapital