The Case for Small Buyouts

RCP Advisors is proud to share the second installment of a three-part research presentation series: The Case for Small Buyouts.

In this series, we have leveraged more than two decades of proprietary data and research focused on lower middle market transactions to explain why we believe small market buyouts have historically produced the highest and most consistent returns in private equity.

Part I of this series outlined the structural advantages observed in small market buyout transactions that contribute to these higher levels of return.

Part II of this series illustrates how these observed structural advantages drive excess returns, and Part III will outline how, historically, small buyout transactions have consistently outperformed other investment areas over long periods of time.

Key Takeaways
There are characteristics of small market buyout deals that have historically helped drive outperformance.

• Opportunity to Partner with Entrepreneurs and Families: Small buyout deals are often more likely to be acquired from/partner with Entrepreneurs and Families who have historically operated their businesses with different motivations than institutional owners and may be more inclined to consider investors on non-price factors.
• Achieving Scale: Smaller companies in the lower middle market often have a greater capacity to increase operational scale than larger companies. The ability to grow revenue and EBITDA significantly in these small buyout transactions can be a significant driver of returns in these deals.
• Improving Small Companies: Small company buyouts present managers with unique opportunities to professionalize management teams, improve operations, implement best practices, and diversify businesses through new customers and product or service offerings.
• M&A is a Valuable Tool: The ability to grow companies organically is important. However, by using acquisitions at lower valuations, smaller buyout managers can potentially increase the financial performance of companies while effectively reducing the entry valuation of their investment.
• Access to More Capital and More Exit Paths: Small companies that can grow to $20M+ of EBITDA will likely gain access to the larger parts of the private equity markets and benefit from the significant amount of capital and increased competition in sale processes, as large PE Funds, Strategics, and IPOs can become viable exit options.
• Higher Levels of Leverage in the Larger Markets: Debt makes up a larger percentage of the capital structures of larger deals and managers are generally willing to leverage companies at entry to a higher multiple of EBITDA than in the smaller market. This allows managers to pay higher valuations and multiples of cashflow to acquire companies, helping smaller private equity sellers potentially achieve greater multiple expansion in their deals.
• Multiple Expansion Can Be Significant: Small buyouts may benefit from a greater opportunity for multiple expansion as they grow and sell through more competitive processes in a more robust, competitive market.
• All of the Above: Small buyout deals can leverage some, or in the best cases, all of the attributes above in a single investment. Combining these characteristics may enhance investment returns at the deal and fund level and is part of why small buyout investments tend to outperform – which we will provide details on in Part III!

To read Part II, please download the PDF below.

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Past performance does not predict, and is not a guarantee, of future results. Any statements regarding private equity market or other financial conditions are based on past, observed market conditions, which are subject change and may be superseded by subsequent market events or for other reasons. Source: GPScout. This Thought Piece and all information contained herein is being provided solely for educational and informational purposes and may not be relied on in any manner as, legal, tax or investment advice or as an offer to sell or a solicitation of an offer to buy an interest in any investment sponsored by RCP or be construed as an offer to sell or a solicitation of an offer to buy any securities or investment products.