Three
Private Equity Success Strategies for the Middle Market
The New Reality for the Middle Market.
Private Equity assets have grown dramatically in the last few decades, 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. With all of this capital chasing deals, strong returns are harder to come by and Private Equity firms increasingly rely on posttransaction value creation to produce returns.
Increasingly, Private Equity firms recognize the need to drive investment returns through post-acquisition value creation.
$1.3 TRILLION IN 2015
In the face of changing market conditions, some Private Equity firms have moved down market or refocused on niche strategies, where competition for deals is much less intense.
Despite the recent closings of a few mega funds in 2016, the average size of buyout funds has steadily declined over the past decade. The average fund size decreased from $300 million in 2006 to $160 million in 2015, attributed to the founding of many smaller funds.
DECREASING FUND SIZES
In 2015, approximately 35% of funds raised were below $100 million, compared to fewer than 25% in 2006.
As a result of these trends, more middle market Private Equity firms are running small funds with lean teams. As such, they face a challenging paradox:
How to drive returns through strategy, execution and operational improvements with a leaner team, amongst a widening competitive field of smaller funds.
Next, we unpack the three success strategies of current middle market Private Equity firms.
The new record in uninvested dry powder within Private Equity portfolios.
01. Specialize
Many firms are adopting a niche strategy where principals of the firm draw on deeper vertical expertise and stronger networks. By staying laser focused on an industry they already know and are known in, Private Equity principals have more success staying top of mind, applying a strategy to their portfolio and understanding the implications of new trends that can change or disrupt a specific industry. While the deal funnel is often leaner for specialist firms, it’s filled with more targeted deals — the result of long-term relationships, deeper operational experience or focused marketing efforts.
Benefits of this strategy:
• Higher likelihood of generating deal flow that is truly proprietary
• Better target identification as result of a deeper network
• More promise for recognizing room for operational improvements
• A highly differentiated value proposition for business owners
Best suited for:
• Principals with deep industry expertise
• Principals with large networks in a specific industry
• Leaner firms that need to narrow the top of the funnel to increase efficiency
02. Leverage Operating Partners
Both large and small Private Equity firms are increasingly utilizing operating partners to extend their involvement into the day-to-day operations of their portfolio companies. While larger firms often bring operating partners in as full-time members of the team, many leaner firms utilize external operating partners, balancing capacity constraints and the need for operational involvements to drive value creation.
Operating partners are often proven business leaders such as former senior executives or functional consultants who can accelerate the value creation of portfolio companies by playing an active role through the lifetime of a given investment.
These partners integrate themselves fully within the day-to-day operations of portfolio companies, often taking on the role of an active chairman. They spend significant time on-site, offer high-level guidance and coaching to the leadership team and help identify and implement growth strategies.
Benefits of this strategy:
• Closer involvement in portfolio companies
• More visibility into portfolio company value creation
• More promise for recognizing room for operational improvements
• A stronger value proposition for business owners who lack leadership depth
Best suited for:
• Firms that look to enhance their ability to drive operational improvements
• Firms that seek to supplement a generalist focus with niche expertise
• Leaner firms that want to offer operational expertise, but cannot afford full-time resources
03. Outsource the “Path to Liquidity”
Leaner firms that find themselves at a crossroads where planning for and executing a liquidity event is challenged by resource constraints are turning towards a consulting model, delivered from the investment banker’s perspective, and built to guide the process in advance of a near-term sale or even years before it’s time to go to market.
Whether a portfolio company needs to build its technology platform to scale, refine its business model, clarify its market position or address deficiencies in operational processes, consultants can benchmark the current state, then prioritize and sequence the right moves to ensure market readiness and to drive shareholder value.
Benefits to this strategy:
• Addition of deep domain experience
• Maximum shareholder value upon an eventual exit
• Avoidance of late stage risks that hold up deals
• A smoother process to build value
• Reduced burden on the firm’s internal team
Best suited for:
• Principals who lack the resources to take a deep dive into operational inefficiencies
• Portfolio companies that seek to pivot from their original strategies
• Leaner firms that need to ramp growth in their portfolio companies, but lack resources
Conclusion
With the increased competition to drive investment returns through post-acquisition value creation, leaner Private Equity firms must continue implementing creative ways to sharpen their value proposition, generate deal flow, and improve their own efficiency.
By understanding how specialization, operations partners or a thoughtfully guided consulting strategy can fill unique resource gaps, Private Equity firms can optimize smaller teams and create more value for their stakeholders now and in the future.
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For more information about Harbor View's advisory services for Private Equity firms and their portfolio companies, visit: harborviewadvisors.com/what-we-do/private-equityservices