2014 State of the Industry

CAPITAL MARKETS

Introduction: Chairman’s Letter

In order to deliver counsel beyond expectations, we want to be as knowledgeable in your industry as we are about law.

Our team is committed to delivering more than just great legal counsel.

We also bring insightful, versatile knowledge of your industry so that

we can partner with you on the strategic direction of your business.

We have experience with guiding organizations or all sizes through

complex business issues, and we know that in order to be your best

legal partner, we have to know your industry inside and out.

That’s why each year we gather some of the top minds in the

capital markets industry to share their insights and best practices.

Some of what they have shared with us and with our guests at the

BoyarMiller Breakfast Forums is presented here, along with some

additional knowledge from our own team. We hope that what

we have gathered here will be beneficial to you.

If you want to hear more about BoyarMiller’s purpose to provide

counsel beyond expectations, build lasting relationships and make

a meaningful difference in people’s lives, or if you want to find out

how our finance and capital formation practice collaborates with

clients, please feel free to contact me.

Best regards,

Chris Hanslik, Chairman

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TABLE OF CONTENTS

Contributors

Expert Insights

MIDDLE MARKET M&A AND PRIVATE EQUITY

HOUSTON’S MARKET: IT’S NEVER BEEN THIS GOOD FOR THIS LONG

PRIVATE EQUITY MARKETS: PLENTY TO GO AROUND

FINANCE & CAPITAL FORMATION PRACTICE LEADERS

THINK YOU’VE GOT THE MARKETS FIGURED OUT? THINK AGAIN

GOVERNMENT POLICIES AND THEIR ECONOMIC OUTCOMES

PUBLIC EQUITY MARKETS: A TALE OF TWO INVESTORS

OUR PARTNERS

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MIDDLE MARKET

M&A & PRIVATE EQUITY

Philip Dunlap & Bill Boyar, BoyarMiller

2014 marks the fourth consecutive year of a stable and strong period for middle market M&A and private equity activity. This prolonged period of growth has many people wondering how long the good times can last. Should we be concerned about a tapering off of the capital markets for M&A and private equity in the middle market? What, if anything, should con-cern investors and sellers about these sectors moving forward? The answers to these questions will guide middle market M&A activity and private equity investing through the end of 2014 and into 2015 and beyond.

M&ATo say that the M&A market in 2014 has been good would be an understatement. The first

half of 2014 has been the strongest first half of a year for private equity deals, both in num-

ber of transactions and the dollar amount of those transactions, since 2007. If the current

pace holds true through the end of the year, 2014 could be the strongest year ever for

middle market M&A.

This robust market has served to increase the valuations for middle market M&A deals.

EBITDA multiples are as high as they have been since before 2007. In 2013, the average

middle market transaction was valued at 6.5 times EBITDA. The multiples change when

looking at different deal sizes. Smaller middle market deals (those between $10 million

and $25 million) saw an average EBITDA multiple of 5.9x in 2013, while larger middle market

deals (those between $100 million and $250 million) saw an average EBITDA multiple of

7.1x. The average EBITDA multiple for larger deals in the first half of 2014 has been 8.3x.

These multiples are anywhere from a half-turn to full-turn better than the multiples realized

in 2006 and 2007.

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Another bonus to the strong middle market M&A sector is the increased competition for

middle market companies. One private equity industry leader has described the market

for businesses with $30 to $75 million in EBITDA as “insanely competitive.” The prospects

for those companies classified as “lower middle market” (typically in the $5 to $15 million

in EBITDA range) are also strong. Many of these companies are coming to the market

currently, which should result in a very large number of deals for lower middle market

companies in the next six to twelve months.

In addition to the higher EBITDA multiples and a more competitive market, private equity

buyers are using more subordinate debt and less equity to finance transactions. In the first

half of 2014, senior debt accounted for an average of 40.3% of the total enterprise value

(TEV) of transactions, which is slightly higher than in recent years. Mezzanine and other

subordinated debt has accounted for 16.9% of TEV in 2014. This is significantly higher than

recent years. As a result of the higher percentages of debt available to finance transac-

tions, private equity buyers’ equity has only accounted for 42.7% of TEV for deals in the first

half of 2014. That equity percentage is the lowest since 2007.

With all of this good news, what could slow down the current market? The risk of inflation

could always affect the credit markets, which would hamper the recent pace. However,

the workout from the Fed that began in 2008 is likely a long-term workout and is not

expected to result in an immediate inflation issue. Similarly, the risk of a drop in the price

of oil is always a risk for the Houston market. However, because the price of oil is funda-

mentally linked to all other industries, a drop in the oil prices would serve as a deflationary

measure and should not materially affect the M&A activity levels.

PRIVATE EQUITYThanks to the new funds raised in 2012 and 2013, US-based private equity funds currently

have approximately $486 million of “dry powder” committed that has not yet been drawn

down. Of this $486 million, approximately 26% is invested in funds that have $1 billion or less

in assets under management. This overhang, which should serve the markets well through

at least 2017, coupled with the lower amounts of equity needed to finance transactions,

should continue to drive substantial activity in the private equity market.

Although there is more dry powder in private equity funds today than in recent years, there

have been fewer new funds (as a percentage of the total number of funds) launched in

2013 and 2014. Established funds continue to account for a large piece of the private

equity market and it has become increasingly difficult for new funds to raise capital and

gain traction in the market. As a result, the private equity industry has become more of an

established players-led industry.

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Middle Market M&A & Private Equity, continued

CONCLUSIONAlthough no financial boom lasts forever, four years of steady middle market M&A and

private equity activity does not mean the good times must come to an end. The market

in Texas, and especially the Houston area, is stronger now than it has been in those previous

four “steady” years. Furthermore, the prospects for the next few years look very optimistic.

The near term should be a great time for sellers to achieve a liquidity event, as valuations

and EBITDA multiples are higher than they have been in seven years. As sellers realize the

market is strong, the overall M&A activity levels should continue to rise. This fact, coupled

with the increased capital that private equity funds have to deploy, should encourage

everyone involved in the middle market that the good times can continue. While risks

related to inflation and oil prices are always present, the optimism surrounding middle

market M&A and private equity activity should not be affected by those limited risks.

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Middle Market M&A & Private Equity, continued

“When I look at the Houston economy today, it looks solid. The market is very competitive. New space is coming on line and being absorbed. We have a balanced market and a lot of good decisions are being made.”

Paul B. Murphy, Jr., Cadence Bancorp, LLC

HOUSTON’S MARKET: IT’S NEVER BEEN THIS GOOD FOR THIS LONG

• In Houston, things have never been this good for this long, which makes some business

leaders nervous – but investors are cautiously optimistic.

• Job growth is largely a myth, as the lowering of unemployment can be attributed mostly

to non-participation. But that picture would be a lot worse if not for the innovations and

creativity of the energy industry. The fundamentals of the domestic supply of oil and gas

mean a lot more work.

• New projects being announced, including improvements to the Houston Ship Channel and

huge investments in petrochemical plant capacity along the Texas Gulf Coast. Between 2010

and 2023, chemical companies have committed $125Bn to new expansion projects in the

U.S., the vast majority of which are in Houston – this creates a positive outlook for Houston’s

future in the next five to ten years. Sources: American Chemistry Council, Exxon Mobil Chemical

• In Houston real estate, experienced developers, private equity firms and investment

banking firms are choosing to be over-equitized, a cautious and healthy approach

that is a definite shift from the mindset of the 1980s.

• Houston’s commercial real estate market looks fantastic.

– MULTI-FAMILY: 24,000 units under construction at the end of Q2 2014, with additional

18,000 proposed. 15,000 units absorbed in the last 12 months with an average occu-

pancy of 91% in all asset classes.

– OFFICE: 17 million square feet under construction at the end of Q2 2014, 67% of which

is pre-leased. 5.7% rental rate increase in first half of 2014, with vacancy trending

downward to 9.8% at Q2 2014.

– INDUSTRIAL: 4.5 million square feet under construction currently, with 4.6 million square

feet of positive absorption in first 6 months of 2014. Market is well positioned for future

rent growth. Source: Transwestern Houston Metro 2Q 2014 Report

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“We know some of our views fall a bit outside of the mainstream. But one of the great things about being a money manager here in Houston is that we don’t have to have the same views that everyone in New York or San Fran-cisco has. We can be a little different, and we think that’s a good thing.”

Rusty Guinn, Salient Partners

THINK YOU’VE GOT THE MARKETS FIGURED OUT?

THINK AGAIN

MISCONCEPTION: I really feel and I really fear that the Fed is going to start tightening. The

Fed is not about to start tightening – the Fed is already tightening. In comparison to other

markets worldwide, U.S. policy is already relatively tight as we come out of this third round

of quantitative easing.

MISCONCEPTION: At this point, interest rates have nowhere to go but up. In 1994, investors

believed that interest rates had hit bottom and had nowhere to go but up. Still more people

held that belief in 1998, and again in 2003, and again in 2009; every smart investor knew

that interest rates couldn’t go anywhere but up. In every case, they were wrong, and many

people missed out on really attractive risk-adjusted returns for U.S. treasury bonds. Having a

long-term view that interest rates will rise is not necessarily wrong – of course, if you extend

the time horizon long enough, it’s a practical certainty. But betting that interest rates can

only go up from here in the short run is anything but a sure bet.

MISCONCEPTION: I obviously don’t want to own bonds right now. Remember that the likelihood

of an expected rise in interest rates is already priced into the bond you’re buying. And since

many of us in Houston already have a lot of implicit or embedded exposure to commodity-

sensitive assets and income through oil and gas, there’s a strong justification for maintaining

a higher bond allocation, in comparison to investing in a lot of different things that look a

lot like the stock market. Consider carefully, if you have a rising interest rate view, whether

the best way to express that is to increase your exposure to inflation-sensitive assets rather

than reducing your exposure to U.S. treasury bonds.

MISCONCEPTION: If U.S. equities are correcting, then emerging markets are going to be down even more! Central banking policy in the developed world has disentangled the

relationship between emerging and developed markets’ equities. Because that relationship

is less strong than it has been in the past, our view is that positive exposure to emerging

markets over the next three to five years is still there.

“There’s something I like to say about markets versus government policy. With markets, you can never predict them, but somehow or another they always work out, and it makes perfectly good sense retrospectively. On the other hand, in government policy, the bureaucrats are always absolutely sure they know how things are going to work out – and it never works that way, and there are always unintended consequences.”

Cliff Atherton, GulfStar Group

GOVERNMENT POLICIES & THEIR

ECONOMIC OUTCOMES

• The Fed’s quantitative easing policies have quadrupled its asset base from 2008 to 2012,

giving it a balance sheet of $4.4 trillion as of July 2014. This leaves the Fed without many

effective tools available for dealing with any crisis that may arise, putting the U.S. in

uncharted territory.

• To date, the geopolitical shocks have not caused market corrections in risky assets on

as significant a scale as would be expected. In large part that has been due to central

bank policy suppressing volatility, but as the Fed ends the third phase quantitative eas-

ing, investors should be mindful of geopolitical risks.

• A single recent regulation on banks – rules on liquidity – ran 399 pages. That’s just one

of more than 400 new regulation banks are wrestling with, each of which is interpreted

slightly differently by one of the five or six regulatory agencies banks are having to

answer to. The regulatory burden on banks is heavy. For some bank clients, that means

providing more information or paying more for accounts in order to offset the massive

costs of banks’ changes to comply with regulations.

• Where we stand, we are at all-time highs in terms of the percentage of national incomes

that goes to corporations and to capital – and at all-time lows in terms of the percentage

of the national income that goes to labor. That inequality could lead to populist policies:

both taxation and some limitations on the ability of companies to generate the same

levels of profitability.

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“If I told you the stock market was on pace to be up 15% on a year-to-date basis, you would probably expect the cyclicals, the higher betas, the higher risk stocks to be the best-performing sectors in the U.S. But they’re not. You rarely see an environment like what we’re seeing right now.”

Rusty Guinn, Salient Partners

PUBLIC EQUITY MARKETS: A TALE OF TWO INVESTORS

The market is being driven by two diametrically opposed ideas – and they may not be

able to exist simultaneously forever. If one narrative dissolves, the entire market will move

toward the new consensus point quickly. Be cautious; with equities priced as a house

divided, there is potential for volatility.

THE SITUATION:The macro players are

bidding up equity prices

and keeping corrections low

THE RESULTS:THE20% highest risk and

highest beta stocks

on the S&P 500 are outperforming

THE SITUATION: The fundamental investors are

positioning themselves bearishly

THE RESULTS:THE20%

lowest risk and

lowest beta stocks

on the S&P 500 are outperforming

S&P

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BOTTOM BETA QUINTILE (LOWEST RISK)

4TH QUINTILE3RD QUINTILE2ND QUINTILETOP BETA QUINTILE (HIGHEST RISK)

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“One of the things I’ve learned over the years is that the public markets are very transparent – everybody can turn on the nightly news and know where the Dow Jones and the S&P closed. But on the other hand, the private markets are very opaque. You don’t see a lot of statistics about them; most people don’t understand them. But they are of increasing importance to the economy.”

Cliff Atherton, GulfStar Group

PUBLIC EQUITY MARKETS: PLENTY TO GO AROUND

• Looking at the deal flow activity in the private market, the number of transactions and

the capital being put to work in the first half of 2014 is greater than we saw even back

in 2007. This could very well be the best year in the M&A market that we have had in

some time.

• In terms of valuations in the middle market, multiples are as high as they have been.

In the first half of 2014, the average as 6.4; last year’s average was 6.5 – these multiples

are a full half-turn higher than they were back in 2007 for this marketplace.

• Worldwide, $3.7 trillion dollars have moved into private equity. It’s not a huge number

when compared to public markets worldwide, but considering this young industry started

in the 1990s, that is pretty incredible growth.

• Why is private equity investment growing exponentially? People are looking at their

options: an optimistic 8-10% return in equities or a 2-3% return on bonds. When you

compare it to other choices, putting money into private equity makes a lot of sense.

• At the same time we had record deals activity in 2012 and 2013, private equity was being

reloaded with plenty of capital. There is plenty of dry powder in private equity funds to

continue to fund transactions.

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Rusty Guinn Deputy Chief Investment Officer, Salient Partners

Rusty oversees the teams responsible for Salient’s outsourced

CIO relationships, multi-alternative fund of funds and system-

atic investment strategies. He brings a variety of perspectives,

having previously served as an institutional asset allocator, pri-

vate equity investor in asset management companies and as

a strategic advisor to large investment institutions. Most recently,

Rust worked with the Teacher Retirement System of Texas, a $100

billion+ pension fund, as the head of Strategic Partnerships and

Opportunistic Investments. There he was directly responsible for

more than $11 billion of Trust capital and commitments across a

multi-asset portfolio consisting of equity, fixed income, credit, pri-

vate equity, real estate, and commodity investments. Rusty holds

a Bachelor of Science in Economics from the Wharton School.

Paul B. Murphy, Jr. CEO and President, Cadence Bancorp, LLC

Paul Murphy leads Cadence Bancorp, which has $7.1 billion

in assets with 80 branches across five states and is privately

held by major pension plans, university endowments and

institutional investors. Previously, Paul spent nearly 20 years

at Amegy Bank of Texas as the CEO and a director. He is a

board member of the Houston Endowment, Inc., the largest

endowment in Texas with more than $1.5 billion in assets.

In addition, he is a board member of the Hines Real Estate

Investment Trust, Inc., Oceaneering International, Inc., the

Fed-eral Reserve Bank of Dallas – Houston Branch, Kinkaid

School, and the Children’s Museum of Houston. He is active

in the World Presidents Organization. Paul holds a Bachelor

of Finance from Mississippi State University and an MBA from

the University of Texas at Austin.

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CONTRIBUTORS OUR PARTNERS

Cliff Atherton, PhD CFA Managing Director, GulfStar Group

Cliff Atherton is an investment banker with more than

25 years of experience in corporate finance and more than

30 years of experience in teaching finance at the graduate

level. As Managing Director at GulfStar Group, Cliff works with

entrepreneurs and family-owned businesses with enterprise

values between $25 and $250 million. His transaction experi-

ence is split evenly between sales to strategic buyers and

recapitalizations with private equity firms. Cliff has served

full-time and part-time on the faculty of Rice University’s Jesse

H. Jones Graduate School of Business since 1980, where he

currently serves as a Professor in the Practice of Entrepreneur-

ship. He earned a BA from Rice University, MBA and PhD

degrees from The University of Texas, and the Chartered

Financial Analyst (CFA) designation.

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Our Partners, continued

Bill Boyar Founding Shareholder, Business Group

Bill’s practice focuses on representing the various parties

involved in the acquisition, disposition, capitalization and

financing of assets and businesses on a national and inter-

national level. He has served as lead counsel on numerous

complex, multi-party acquisitions and project financings

with significant experience in corporate finance, private

equity and mergers & acquisitions. He regularly assists

clients in their strategic planning and capital formation

processes, maintaining a network of private and institutional

clients and contacts worldwide.

Gary Miller Founding Shareholder, Business Group

Gary’s practice is focused on corporate and commercial

matters with emphasis on mergers and acquisitions. In

addition to M&A work, he also has extensive experience

in capital formation, contract negotiations/documentation,

factoring and day-to-day representation of corporations

and other business entities. Gary is often called upon to

represent insurance agencies in their capital transactions

as well as United Kingdom and Norwegian based compa-

nies in their business activities in the United States.

CONTRIBUTORS PRACTICE LEADERS

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Steve Kesten Shareholder, Business Group

Steve’s practice includes private placements and other

sales and purchases of debt or equity securities; mergers,

asset acquisitions and sales; formation and representation

of private equity funds, venture capital funds and hedge

funds; entity selection and formation (including drafting

complex limited liability company and partnership agree-

ments and corporate charters having multiple classes of

common and preferred stock); and general contract review.

He also has experience representing both lenders and bor-

rowers in asset-based lending transactions involving senior

lenders, mezzanine lenders and factoring companies.

Stephen Johnson Shareholder, Business Group

Stephen’s transactional practice includes mergers and

acquisitions, asset and stock purchases and sale transactions,

private equity investments, formation of business entities,

restructuring, capital formation, contracts and similar agree-

ments, and general corporate matters. He places the utmost

emphases on providing clients with the highest quality of

service in an efficient and effective manner.

Gus Bourgeois Shareholder, Business Group

Gus’s practice involves a wide variety of corporate transac-

tions including the acquisition, financing and disposition

of business entities through asset and stock purchase trans-

actions, sales of debt and equity securities, and complex

domestic and international transactions. His clients range

from small, start-up businesses to established enterprises

with international operations.

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Practice Leaders, continued

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