Private Equity Firms as Middle Market Business Buyers

By Generational Equity


One of the key concepts we cover in our exit planning conferences is the idea that one buyer is no buyer. What this means in the M&A industry is that it is vital to cast as wide a net as practically possible when you begin to approach buyers.

If you start out assuming your “perfect” buyer will be the competitor across the street, you will ignore the fact that you might be able to generate a greater return by approaching more targets. To work towards this you need to create a “limited auction,” where you get as many buyers interested as possible to hopefully obtain a more optimal deal.

Private Equity Firms: An Often-Ignored Business Buyer

One group of buyers that middle market business owners ignore far too often are private equity firms. The prevailing view of this type of buyer is that they only invest in very large companies in “sexy” industries. Certainly a good portion of these firms create funds that do indeed focus on mega deals and that is their area of expertise.

However, a significant and growing number focus on a different model: creating platform companies in industries that they then grow by making related, additional acquisitions. Often the initial investment is a larger company. But add-on acquisitions are often much smaller and are usually classified as being in the middle or lower middle market.

The private equity firm then combines 5-10 companies under a newco (new company) structure, providing financial expertise, management experience, marketing muscle, and sales/operational improvements to each, which further enables growth in revenue and profits over time.

A great example of this strategy in action was recently publicized:

Incline Equity Partners (“Incline”), a Pittsburgh-based lower middle-market private equity firm, announces the sale of Revolution Dancewear. Based in Niles, IL, Revolution is a leading designer and marketer of specialty dancewear, footwear, and recital costumes. Revolution’s unique business model is focused on sourcing quality products and selling directly to its more than 12,000 dance studio customers.

Through Incline’s ownership period, the Company saw significant investments in management that allowed the business to achieve substantially increased scale. A new CEO, CFO, and CIO were recruited to facilitate the founder’s transition to the Board and to build a robust infrastructure.

According to Leon Rubinov, Partner with Incline:

“We are very proud of what we have accomplished along with the management team at Revolution. We knew to grow the business, we needed to expand both geographically and into new product lines. The team achieved these goals through organic initiatives as well as through three acquisitions. Our combined efforts helped the Company more than double in size during our ownership.”

There are a couple of key takeaways from the information about this transaction. First and most importantly, Incline INVESTED in Revolution in order to grow it. They did not, as far too many business owners believe, tear the company apart by selling its assets/divisions/subsidiaries over time.

This investment strategy clearly paid off in the longer-term. And this is typical of how lower middle market equity firms operate.

How Do Private Equity Firms Create Value for Middle Market Businesses?

The American Investment Council (AIC), a trade group created by equity firms, has produced a compelling video that outlines how lower middle market firms create value for their holdings: What is Private Equity?

According to the AIC’s research, “Private equity invests capital in companies that are perceived to have growth potential and then works with these companies to expand or turnaround the business. This capital is contributed by large institutional investors and is organized into a fund.”

“After three to seven years of ownership and working with the company, the fund manager will seek to ‘exit’ the company by taking the business public or selling it for a higher valuation than it was purchased. This exit distributes profits from the sale (‘returns’) to the investors in the fund and the fund manager.”

This description matches what we learned earlier about the Revolution relationship with Incline.

One area of confusion we encounter is regarding the definition of private equity vs. venture capital. There is an important distinction. Again, according to the AIC:

Venture capital funds invest in companies at the seed (concept) and start-up (typically in the first ten years) phase of a company and often take minority stakes. Private equity funds invest in more mature companies through buyouts and buy-ins and work to improve efficiencies and boost growth.

A second key concept that we learn from the Incline/Revolution press release is that you don’t have to be booming software company (or in a high tech industry at all) to be attractive to an equity firm.  I mean really, dancewear?   Can you find any glamor in that?  Incline did because they did their research and determined that there was a huge opportunity to grow this industry by applying professional sales/marketing/management skills (and find the optimal deals to bolt on to this platform) over the hold and grow period.

Private Equity – What’s the Catch?

If this sounds too good to be true, for many business owners it is. Keep in mind that ultimately private equity firms exist for one reason only: to generate returns to the fund investors. They are hard negotiators and will try to get the best deal possible when making investments in middle market companies.

Since many of these firms invest in 5-10 companies every year, they are incredibly savvy and will NOT leave any chips on the table for you to grab. Consequently, you will most likely need professional M&A guidance to close an optimal deal with these types of buyers.

Also, keep in mind that in order to acquire 5-10 deals per year, they will often look at more than 1,000 opportunities. In order for your company to stand out in this milieu, it is vital that you provide documentation that is not only accurate but also presented in the format they prefer.

Again, a professional M&A advisory firm will be key to packaging your opportunity in order to get it reviewed/analyzed.

This is why Generational Equity has been so successful over the years. No firm has closed more transactions in the North American lower middle market than us. Don’t take my word for it, Thomson Reuters research is your proof:

You get the picture!

If you are interested in learning how we can bring our professional, proven process to bear for your company, please call us at 972-232-1121, or visit our website, provide us with your info, and we will be in touch.

By Carl Doerksen, Director of Corporate Development at Generational Equity.

© 2021 Generational Equity, LLC. All Rights Reserved.