Table of Contents:
Do Mid-Market PE/VC funds out-perform small & big ones?
a great article from Daniel Primack of peHUB:
some unpublished research by Josh Lerner (HBS) and Antoinette Schoar (MIT Sloan). They looked at how changes to fund size and firm size affect returns, and found that there is an apparent relationship.
Lerner and Schoar first took the universe of all mature VC and buyout funds (those raised through 1999), and discovered an inverted U-shaped relationship. Basically, mid-sized funds outperformed both small and large-sized funds. Peak performance was at around $300 million (note: the researched time period is admittedly dated).
They then broke out the types of funds, and found that the inverted U-shape is sharper and most statistically significant for VC funds than for buyout funds. In this breakdown, the peak VC size was $280 million compared to $1.2 billion for buyout funds.
So is the answer to have a mid-sized fund? Well, not exactly, Lerner and Schoar didn’t actually find too much performance variance based purely on size. Sure there was peak performance, but it didn’t vary too much from the high and low-end quartile benchmarks. For example, a $5 billion buyout fund had a predicted return of just 1.2% lower than a $2 billion buyout fund.
What is important, however, is the rate at which a firm’s fund sizes grow. Lerner writes: “We find that growth has a substantial negative effect on growth: A doubling of fund size, all else being equal, leads to a fall in IRR of -5.3%. This analysis suggests that a group that had a 25% IRR in its $1 billion dollar third fund could expect a return of only a little below 20% if it went and raised a $2 billion fund next.”
The related chart is fairly remarkable, in that the negative correlation between fund size growth and performance resembles a very steep hill.
So what is ultimately important for firms like USV and Benchmark isn’t purely the number of dollars in their current funds, but rather how that compares to the dollars in its past and future funds.
source: Daniel Primack of peHUB
Trends Driving Mid-market PE activity (2008)
see also private equity trends
The tightening of the credit markets and the resulting sharp decline in high-leverage megadeals has generated strong interest in middle-market transactions -- a trend that is expected to continue at least throughout 2008.
Middle-market transactions are projected to remain in focus because they do not depend on syndicated debt, according to PricewaterhouseCoopers' transaction services group's midyear mergers and acquisitions forecast for 2008.
In addition, three regulatory factors may drive an increase in middle-market deals -- and possibly all deals -- before year's end.
Focusing on deals with low levels of debt where hands-on operational and management experience can offer great rewards, firms that are more nimble than their megacounterparts are able to find many private businesses to partner with.
Keys to success in the mid-market:
As private equity firms deploy more capital in the midmarket, and because middle-market deals are unique, getting the right fit and the right experience can be critical to success. Four basic issues make these deals unique.
Social issues.
Midmarket deals frequently involve founders or family operators who are key to a private equity target's success and growth. It's important to match the financial expertise of the investor with the operating expertise of the owner-operator with sensitivity, whether it involves the introduction of a new finance officer, the addition of debt to the target's balance sheet or the creation of incentive-based compensation plans where there were none.
Changes in senior management also require a sensitive touch. These changes are often characteristic of the midmarket deal, and implementing any of them suddenly and without a clear understanding of the benefits could spell disaster.
Structure issues.
Middle-market targets may be organized in a way that is not tax-efficient for investors. Therefore, understanding the use of creative and flexible flow-through structures for making an investment, such as LLCs, is important. Experience matters when it comes to understanding the alternatives these structures offer for the allocation of profits, losses and distributions to target owners and investors alike, and for creating critical incentives for management to drive growth.
Special skill also is required to address and balance the economic and tax concerns of the target owner's rollover equity -- such as maintaining a single-level of tax and maximizing capital gains -- and the investor's goals -- such as qualifying for consolidated return filing, or a step-up in tax basis and amortization of the investment.
Capitalization issues.
Growth through add-on transactions often drives returns in midmarket investments, while high leverage drives the megadeals. In fact, many midmarket deals are initially funded entirely with equity, sometimes later refinanced.
The result is that the post-money capitalization of a midmarket target follows its own pattern, and creates its own dynamic -- all with a profound effect on valuations and returns -- and all requiring a different approach to financial modeling.
Most important, because add-on transactions are so crucial in the middle market, the ability to complete them quickly and in a cost-efficient manner with positive effects on the target's balance sheet and P&L statement takes deft handling.
Supporting players.
The accounting firms, lenders, investment bankers, lawyers and others that source midmarket opportunities for investors are all cast from a special group focused on the middle market. Dealing with any one of these advisers will put all the necessary experience and resources of the other advisers within the reach of investors, enabling them to close the deal quickly. This special group also is best-suited to stay ahead of market trends and solutions that can create commercial efficiencies.
It is worth noting that this "fit" is as important to cost control as it is to overall success. Successful midmarket deals demand advisers who staff their deals with lean-and-mean teams, and provide the same partner and team from deal to deal. So getting the right fit and the right experience can make the difference between closing the deal and losing it.
Source: Mitchell S. Ames is a member of Pepper Hamilton LLP's corporate and securities practice group in New York City.
Details about firms - Private Equity Florida
see also: Venture Capital in Florida
Brockway Moran & Partners
- smaller deals of <300 million
- focus on growth companies (not as focused on "family owned" sector like Trivest
- put 40 % equity in, and rest if financed with debt
Trivest Partners
Trivest Partners, L.P., a private investment firm, is a leading provider of equity for lower middle-market corporate acquisitions, recapitalizations and growth capital financings. Since its founding in 1981, Trivest has sponsored more than 145 acquisitions and recapitalizations, totaling more than $3.5 billion in value.
- slightly smaller "space" than Brockway Moran & Partners
- most deals average $50-$150mm
- focus solely on "family owned businesses"
- trend is favorable as they focus on "baby boomers" generation aging, and offer PE as an option to this group of business leaders that dont want to sell out to a "strategic buyer" (who might change the culture of the firm), and instead partner up with a PE firm, who will preserve the culture, and give an equity option to the employees...."help transition and transform them"
- demographics play
- credit crunch less of a factor
- lower multiples than megadeals, putting less debt on the companies than the big deals (meaning that the credit crunch is less of a factor)
- key to success: really connecting with the founder, and staying "under the radar" of the mega funds (by partnering more with business founders, you build relationship, and hope the business will chose you rather than the bigger PE funds)
Private equity vs a Strategic buyer:
- PE can be outbid by strategic buyers because they dont have the financing contingencies, and can do it off of their balance sheets
- sales pitch: "PE as an option to this group of business leaders that dont want to sell out to a "strategic buyer" (who might change the culture of the firm), and instead partner up with a PE firm, who will preserve the culture, and give an equity option to the employees...."help transition and transform them"
How are the deals financed?
- PE firms put cash in, and then they go externally looking for debt financing:
- But, recently....with the credit crunch, there are alot of people out of the market that dont have CDO's, CLO's, redemptions, secondary debt is trading now at high 80's to low 90's cents on the dollar
- Brockway: "put 40 % equity in, and rest if financed with debt, and 60% of that is senior debt (Libor +400-450), and the rest is Mezzanine debt (15%)....which may be less leverage than goes into a home purchase. see also our discussion about raising capital - ideas for the entrepreneur
- see our discussion on private equity fund raising and Venture Capital Fund Raising
Tax issues:
- capital gains tax: if there is a change in parties (US election '08), this tax will likely rise....effecting PE, and entrepreneurs
Interview on Squawk Box:
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