Over the past few months, a common theme in our conversations with middle-market private equity executives has focused on this: the supply of money continues to exceed the supply of solid middle-market companies that will trade at a reasonable multiple. In this dynamic environment, funds in our network have been re-wiring their investment plans to adjust to marketplace realities, including implementing one or all of the following strategies:
- Add-ons – Funds that are choosing to step away from auction processes with high-paying strategic buyers, public companies, and larger private equity firms are increasingly relying on buying smaller platforms and pursuing an aggressive add-on strategy. This indicates that PE shops see less operational risk associated with integrating bolt-on acquisitions than overall market risk related to overpaying for a large platform.
- CEO First – Many funds in our network are developing investment theses around senior executives and micro niche markets, allowing them to go into a deal process with an industry leader, immediately gaining a leading edge, serious credibility, and, hopefully, an inside track to a partially marketed deal. This competitive advantage helps the fund to win more deals and put capital to work in situations that may not be fully auctioned and ensure that the CEO and the fund are lined up on day one.
- Industry Focus – In tune with the above bullet, many funds are narrowing their investment focus to a specific industry or vertical in order to get an earlier and more complete look at deal flow. This strategy allows for a streamlined process of originating and closing on deals with detailed knowledge on the risks and potential rewards of making an investment.
The lifeblood of the private equity business is relevant and realistic deal flow and we expect the trends mentioned above to continue unless other substantive changes, such as another recession or rising interest rates, once again cause the fundamentals for middle market investing to shift.