Four Reasons Middle Market Owners Shouldn’t Wait For Private Equity
Right now, private equity firms are sitting on $356 billion of cash and commitments from investors, all of it earmarked for company buyouts.
Interest rates are low, so structuring leveraged transactions is highly doable. And there are many thousands of founder/owner/CEOs of middle market companies (sales of up to $1 billion or so) who bravely managed through the past half dozen years of economic chaos and would now look kindly on a reasonable offer to buy part or all of their company.
Sounds like a match made in heaven.
But guess what? I don’t expect a boom in private equity-financed buyouts of middle market companies. The forces shaping the private equity business instead are putting an increasing focus on very large buyouts, away from the middle market where private equity got its start, and I expect that to continue. An annual review of private equity activity by the smart people at Bain & Co. seems to confirm my view of the marketplace.
1. The big are getting bigger in the private equity world, and they control more of the buyout money. As Bain reports, “nine mega-funds closed in 2013, attracting more than $5 billion each and accounting for 48% of the total capital raised by buyout funds.” Apollo Global Management (APO), the Leon Black-run private equity firm, alone raised $17.5 billion for a new fund.
2. Those big funds have to concentrate on big deals to put all that money to work. Think of Heinz and Dell, which combined accounted for almost $50 billion in deal value last year, out of a global total for deals of $231 million, Bane reports. “It may be just too much work,” to put a major fund to work based on smaller deals, one fund manager explained to Bain.
3. Limited partners that invest in private equity funds – the pension funds, state retirement funds and others – are moving to work with fewer buyout firms, and that process also concentrates more assets in a small number of hands.
4. A growing amount of private equity money is going into refinancing of existing private equity deals, rather than buying new companies. A company is sold from one private equity firm to another. That has become a third majorexit strategy – the most commonly used in Europe last year — along with selling to a strategic buyer or taking the buyout company public in an IPO.
Don’t get me wrong. Private equity purchases of middle market companies could increase. But I doubt we’ll see a significant shift in funds to non-giant deals. The bias toward big is well established. Bane estimates that 15% of companies with an enterprise value above $500 million are already owned by private equity funds; just 3% of companies with an enterprise value below $100 million are thusly owned.
With increasingly vibrant financial markets, though, middle market owners have options. Strategic buyers are becoming more active again. The market for IPOs is strong. And my firm’s specialty, employee stock ownership plans, or ESOPs, is a versatile tool that allows founders to gain liquidity in a partial or complete sale of the company, realize tax benefits for both seller and the company, and turn employees into highly motivated owners.
Private equity’s cash glut might not find it’s way to you, but the good news is, even if you’re selling your business, you’ll be fine without it.
In coming weeks in this space, I will be writing more about exit strategies for owner-entrepreneurs. And I welcome your comments both here and to me directly at CEO@verit.com.