Exits have continued to stall and dry powder keeps piling up, but middle-market private equity professionals say there are still opportunities to create value — if you know where to look.
Firms like Lateral Investment Management and Searchlight Capital say they are playing from the old rule book, buying lower middle-market assets at good prices, building them out, and selling them at attractive multiples.
One opportunity for value creation is to find businesses with no existing private equity or venture capital buy in, known as bootstrapped companies, said Richard de Silva, management partner at Lateral, a growth buyout firm focused on this section of the market.
“Proprietary originations blossom in an environment like this,” he said, adding that there are huge opportunities in the often-overlooked space if a firm can do the leg work and find the right targets before they grow too much. “The opportunity is to build up these small companies to be mid-sized and hopefully then sell them to strategic buyers."
Lateral published a white paper in June on profitable bootstrapped companies and how they are among the “last untapped opportunities for private equity.” Separately, the firm estimated that there are approximately 200,000 such companies in the U.S. with around $100 million in revenues at any one time.
“In the 1990s and 2000s there used to be companies like this across the country that attracted investment from private equity firms that focused on proprietary originations. But now traditional growth firms like TA Associates and Summit Partners have bigger funds focused on deploying $250-500 million equity checks for which targets need to have billion-dollar-plus enterprise value,” he said.
“Our argument is that there needs to be a re-thinking of lower-middle-market buyouts and a return to this model that existed before. There is room for a whole new generation of [private equity] firms, because the prior generation vacated the space by growing in size.”
Middle-market PE firms generally focus on niches, in particular identifying areas with “severe pain points.” For Lateral, cybersecurity protection is one such example. Larger firms can afford huge internal cyber protection teams, but mid-sized companies with just a few hundred employees must instead look to outsource or rent enterprise-grade cyber protection software solutions that mimic internal teams.
The companies offering those software solutions are one such niche that the firm is looking to invest in. The exponential improvement in AI technologies has also meant that the cost of building this sort of software is cheaper than it has ever been before.
“Opportunities like this are hidden in plain sight and every year the market is refreshed with new companies,” said de Silva.
Another firm operating in this part of the market is Searchlight Capital, which was founded by Apollo, KKR, and CVC alumni who felt that there were better opportunities in the middle market, which they are aiming to capitalize on by homing in on the handful of sectors they had prior experience in, such as media and industrials. The “old school private equity” approach that the firm takes is “probably less fashionable than many other strategies out there” but has allowed the firm to execute deals for recurring revenue businesses and to add a lot of operational value as well, said Erol Uzemeri, one of the founding partners.
“There's a lot talked about in the market about how it's hard to get exits, but there is no issue at all exiting good companies that are growing nicely,” he said. “Firms have just gotten into a challenging situation because they have paid too much for those businesses — that is the issue.”
One of Searchlight’s portfolio companies is TelavisaUnivision, one of the largest Spanish-language media businesses in the world. When it was initially acquired, it did not have a streaming service but relied entirely on broadcast television. The firm saw that it would be able to add this to the business and reposition it as a global subscription model.
“We really created a growth vector for what was structurally a more challenged business given paid satellite television subscriptions were going down,” Uzemeri said. “Everyone saw it, but sometimes these assets need actual investment and expertise to grow again, and that means buying it at the right price, having the capability to invest and grow the business, and the right vision to look around those corners.”
