How common is multiple expansion in PE?
Not a PE associate so this might be a stupid question, but wondering how common "multiple expansion" really is in deals. Especially for mature companies (but also in general, unless really early-stage companies which isn't really relevant for PE/LBO)
AFAIK, growth is highly correlated with multiple, and naturally growth decreases over time. Intuitively, it feels like more than multiple expansion, things like debt paydown and EBITDA expansion would more frequently drive returns in an investment.
In the lower middle market, multiple expansion is very common. This is since you are transforming a founder-led company into a professionally managed business with ERPs, budgets etc. In addition, there are fewer quality-assets for the buyers (mid-market pes) which drives multiples higher.
As for the mid-market/large-cap, I'm not sure, but I would assume value creation there relies more on deleveraging, but there dhould still be some multiple expansion especially if you drive the entry price down with cheaper add-ons.
So you think a business is worth more because you help them set up an ERP and make nice budgets. This is why founders hate PE Associates on their boards.
I didn't say thats the only reason for multiple expansion, if you can managed to read more than the two first sentences you would know that buddy.
Also, it's not about what I think the business is worth, its what the mid market thinks its worth. And consistently they are paying more, since they don't have to lead the transition from founder-led to a professional company. And yes that includes things like budgets, ERPs, a CFO etc.
I am at a MF and I have never seen a team underwriting a multiple expansion as base case when going to IC. Sometimes there is even a multiple contraction when base case is IPO or the target will be very large that only a handful of strategics can acquire it
Okay but what’s you’re typical base case IRR?
>20%, 2.7-2.8x
It's never something to expect, just a happy occurrence when it does happen. Deals are underwritten on ARR (for software) and EBITDA growth + debt paydown as you cited.
Fellow not PE associate here. I always though multiple arbitrage/expansion was an LMM thing where you can roll up smaller businesses at low multiples into a single larger enterprise which because of its size and lower customer concentration is attributed a larger multiple -- even if there aren't any improvements to operational efficiency.
At larger-cap funds this strategy doesn't really apply and any difference in multiples is determined by factors outside of the sponsor's control like business cycle and sector trends.
Rarely part of underwriting but more often than not ends up being the main return driver (for good outcomes).
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