Three aspects of market diligence private equity firms should seek

It is no secret to private equity professionals that the current M&A market is one of the craziest in recent memory. Although the onset of COVID-19 led to a downturn in deal activity in the first and second quarters of 2020, the decline was short lived with 2021 on pace to experience a record number of deals due to a confluence of trends over the past five years.

  • Global uncalled private capital focused on buyouts was $1 trillion in 2020, two times more than what was available in 2015 [1]
  • U.S. private equity funds raised $1.2 trillion in capital in the last four years (2017-2020), even with the downturn caused by COVID-19 in 2020, compared with $720 billion raised in the previous four-year period (2012-2016) [2]
  • Although federal funds rates increased over the previous four years, the Federal Reserve purchased $2.9 trillion of assets in 2020 in response to the coronavirus, a 75% increase over 2019, leading to a decline in the fed fund rate back to just above zero [3]

All of this capital and cheap debt has supercharged the deal market in the U.S. Even with the pandemic slowing deals in the first half, 2020 saw the highest number of private equity deals in U.S. history with 5,789 and 2021 is on pace to significantly pass that number. [4]

The increased competition for deals and the need to get capital deployed has led to high purchase price EBITDA multiples. In 2020 in the U.S., the average EBITDA purchase multiples paid by private equity firms was 11.4x, up from around 9x in 2015. Anecdotally, Baker Tilly’s transaction advisory group has seen deals in manufacturing and distribution that would have gone for 4x-6x EBITDA five years ago, now closing at 7x-9x. [5]

In this high-multiple environment, private equity firms need to achieve substantial growth to hit their internal rate of return (IRR) hurdle rates. This makes it more important than ever to undertake strong market and commercial diligence in order to provide the foundation for a strong Day One growth strategy and value improvement plan for the target company. Below are three aspects of market diligence private equity firms should seek to understand as part of developing their growth strategy.