Private equity interest in mid-market businesses continues to grow

When you decide it’s time to sell your business, or if you want to raise capital, one of the most important buyer groups you should consider approaching are private equity (PE) firms. Quite often, for reasons I cannot quite clasp, PE firms are way down on the list of potential buyers for business owners looking for an exit. Here we explain why PE firms should be on your radar, and a look into recent market activity.

What is PE and what are PE firms?

The shortest definition of private equity (PE), which is often over-complicated, is equity that is not publicly listed or traded. PE firms, therefore, are investment firms that invest specifically in this particular sort of equity. In most circumstances, the source of PE investment capital derives from high net worth individuals (HNW) and investment firms that purchase shares of private equity firms…simple right? Most of the PE industry is made up of large institutional investors, such as pension funds, and large private equity firms funded by a group of accredited investors.

Market data strong, and increasing

In a recent article, we discussed currently bloated business valuations. In this blog, we look at recent PitchBook1 data, in particular, PE activity, as to additional reasons why. The data provides further evidence that it’s a sellers’ market, continuing to suggest now could be the time to look for an exit. The data shows that mid-market PE activity (deals valued below $200 million), within the United States, has continued to increase during 3Q 2017. In the year to September, US$233 billion was invested into mid-market businesses through a total of 1,652 deals, setting a massive US$141m average price tag per ticket. Due to the combination of sustained low-interest rates, which translates to cheap debt and a low market risk premium, platform roll-ups, and large cash reserves on corporate balance sheets which have translated to high company valuations. Combined with a lack of quality companies recently up for sale, it is allowing many businesses to seek out what kind of prices they could fetch, by setting a high ask price, and more often today those high asking prices are being met.

The PitchBook data is positive for potential sellers for a number of reasons.

1) Firstly, as already mentioned, the data shows that PE firms are very active in the mid-market, and this has been growing since the end of the global financial crisis, hitting its peak during 2017.

2) Secondly, it supports the ideas most analysts are throwing around that it is, and will continue to be, a “seller’s market”. Dry powder is a slang word used in the industry which refers to the level of committed capital ready but not being deployed by equity firms. In other words, the cash is sitting dormant waiting to be invested. This dry powder has grown dramatically over the past five years, and this continues to increase as more and more investors seek the tremendous returns available. This leads to increased investment in privately held companies. Dry powder money needs to be spent, in particular as interest rates remain at low levels.

3) Interest rates need a special mention. Despite recent inflation, they remain at low levels when compared to historic levels. A significant portion of all deals involve some component of financing, and this is especially the case for deals relating to PE firms. Therefore, cheap financing means PE firms can justify more deals, as expected return thresholds are lower, a translation of low-interest rates.

4) Quality deals are something all investors seek, from Mum and Dad investors through to the largest investment bank. There are however limits to how low investors are willing to go in regards to quality, and PE firms are no different. From a private equity standpoint, the only real dampening factor in this bullish market is a simple fact that there are not enough quality deals. This increases their dry powder, and increases pressures to buy the quality companies when they come on offer. Although the definition of quality will vary from PE firm to PE firm, there simply are not enough businesses in the market presently for equity firms to analyze for investment purposes. So when they buy, they are willing to pay more.

Only so many seats on the train

This is a large generalization, and rules are often broken, but the majority of PE firms will look to target 2-3 companies annually. With that said, they will review hundreds if not thousands of companies before they make even an indication of interest. There is also a misconception that you only have one shot to send in your investment proposal, and that is simply not the case. PE firms have very short-term memories, and at the end of the day, they want to make a return. You won’t get black marked unless you annoy someone senior. What this ultimately means to business owners thinking about selling is that they are quite literally missing out on potential opportunities to sell their company and at increasingly high market multiples. The market will compress, and we will not see them again at this level for quite some time.

Bottom line

PE investment into the Mid-market is at a solid level and is continuing to increase. The Q3 2017 data showed improving conditions, and we expect the full year 2017 report to remain positive. That coupled with the increased market multiples we are seeing is painting a very lovely picture if you are looking to sell your business. PE firms focus on unlisted entities, and for this reason, the biggest constraint they face is generally finding enough quality firms a year to invest in. We have seen this becoming an issue, and with dry powder on the rise, they will pay a premium for what they class as a quality investment. You do not have one shot, but you could lose this one. If you have not considered selling, consider it.

1 – The US PE middle market keeps growing, PitchBook News, https://pitchbook.com/news/articles/the-us-pe-middle-market-keeps-growing (last visited Jan 17, 2018).

Sam Grice
Sam Grice graduated from the University of Auckland in 2012. He holds two Bachelor degrees; a Bcom majoring in Economics and a BSc Majoring in Statistics. On graduation Sam worked for one of New Zealand’s largest investment banks as an Equity Analyst. He covered the Energy and Oil and Gas sectors. Sam is a published author of equity research, and is currently CEO and Founder of a Tech start-up. Outside of work Sam loves sports, and like most New Zealanders loves Rugby. He enjoys the outdoors and completes at least one great hike every year.
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