Download Three Trends in Middle Market Private Equity

Three Trends in Middle
Market Private Equity
Harbor View Advisors
The New Reality for the Middle Market
With persistently low interest rates and public equity
market indices hitting record highs, investors have
increasingly turned to private equity funds in their
search for returns. In this low-return environment,
private equity funds have enjoyed unprecedented
fundraising success, accelerating the decades-long
surge in private equity assets and new fund formation.
The post-recession environment, with its surging
private equity assets and accommodative credit
markets, has intensified the trends. With so much
capital in the market, financial buyers and strategic
acquirers compete in rapid-fire auctions, driving
valuation multiples higher.
The current environment has also encouraged growth
in new fund formation. With the proliferation of first
funds, the median fund size fell to historic lows in
2015.
Global private equity assets have grown dramatically,
increasing from $30 billion to $4 trillion in the last 20
years. By year-end 2015, uninvested dry powder in
private equity portfolios stood at a record $1.3 trillion.
The Declining Median Fund Size
The Proliferation of Global Dry Powder
Source: Preqin
2015: MORE SMALL FUNDS
In 2015, approximately 35% of funds raised were below
$100 million, compared to fewer than 25% in 2006.
$1.3 TRILLION IN 2015
The new record in uninvested dry powder within global
private equity portfolios.
The round of mega-funds raising their latest buyout
vehicles in 2016 tempered the fall of median fund
size, but it is clear that middle market managers must
contend with a crowded market with ample players
looking to put capital to work.
As private equity markets have grown and matured,
the market for private assets has become more
efficient. In this competitive environment, private
equity firms face a greater challenge to generate
investment returns. According to Professor Steven
Kaplan at the University of Chicago, average IRR fell
from 22.4% in the 1980s to just 16% in the 2000s, with
realized multiples of invested capital dropping from
3.7x to 1.7x.
Operating budgets of smaller funds require managers
to face the competitive environment armed with lean
teams. The teams must source, close and manage
investments, while fundraising and maintaining
relationships with investors. They face a challenging
paradox:
Gone are the days when returns could be generated
primarily through deal sourcing. Today's private
equity investors must complement effective deal
sourcing with post-transaction strategic and
operational improvements in order to meet return
expectations.
How do investors drive returns through strategy,
execution and operational improvements with a
leaner team, amongst a widening competitive field?
On the following pages, we explore three trends that
firms are implementing in response.
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Three Trends in Middle Market Private Equity
01.
The Rise of the Specialist
Newly founded, smaller funds and established firms
wishing to gain an edge are gravitating towards
industry specializations.
Industry focus can also differentiate an investment
brand in a crowded market and establish the firm as
the buyer of choice.
Often, the industries where firms choose to
specialize are a product of the founding principals'
backgrounds as former operators or deal
professionals in the space.
In a widening competitive field with expanding
valuation multiples, sellers receive compelling
offers from a range of financial buyers. Sellers
increasingly favor a buyer who brings more
than just capital to the table. A buyer's industry
expertise and track record of success are important
factors to a founder who plans to retain an
ownership position post-transaction.
By choosing an industry that principals know
and are known in, they are able to leverage their
experience and network in sourcing and screening
transactions.
02.
The Age of the Operating Partner
In a market that rewards specialization and demands
efficiency, firms are increasingly leveraging
operating partners to build value within their
portfolio companies.
Still, other firms have adopted an executive-inresidence model, where they specifically search
for an opportunity to place the executive in a
permanent leadership role.
Operating partners are typically proven business
leaders who play active roles through the lifetime
of a given investment, either as board members or
operators.
With operating partners in the mix, firms can
jump start their expertise in a specific industry.
Leveraging operating partners also allows fund
managers and deal professionals to focus on
sourcing and closing new investments in portfolio
companies and strategic add-on opportunities.
Some firms opt to bring operating partners in as fulltime members of the team, while other firms utilize
experienced executives as external advisors.
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Harbor View Advisors
03.
The Ascent of Outsourced Consultants
Private equity firms are more frequently engaging
outsourced functional consultants when sourcing and
evaluating prospective investments and managing
current portfolio companies.
Consulting during due diligence may include:
•
Product comparison studies
•
Industry evaluations and outlook
Before making an offer, private equity firms engage
outside consultants to assist in evaluating investments.
During due diligence, firms bring in consultants once
the deal team completes initial analysis and determines
that the investment is compelling.
•
Technology assessments
•
Accounting, tax and quality of earnings reports
•
Customer satisfaction analyses
More and more, as competition intensifies and sellers
can dictate strict process deadlines, firms are required
to bring on consultants in earlier stages, often before
exclusivity is granted and in heated auctions, prior to
LOI submission.
Consulting post transaction close may include:
Post transaction close, firms bring in consultants
at different stages to evaluate, recommend and
implement strategies for growth.
•
Market mapping
•
Technology roadmaps
•
Pricing analyses
•
Supply chain optimization
•
Exit readiness assessments
Conclusion
Private equity firms have risen to the challenge of
competing in today's complex deal environment
where they are required to do more with less.
Harbor View Advisors provides outsourced services
to private equity firms ranging from market studies,
market readiness assessments, add-on acquisition
sourcing and transaction execution services.
Establishing industry specializations, leveraging
operating partners and engaging outsourced
consultants have emerged as three trends in
response to this competitive and challenging
environment.
To learn more about Harbor View's consulting,
corporate development and investment banking
services, visit www.harborviewadvisors.com.
We expect firms to continue to employ creative
solutions as they work to source and close
investments and build value within their portfolios.
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