The Case for Small Buyouts

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

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

Part I of this series will outline the observed structural advantages in small market buyout transactions that help lead to these higher levels of return.

Part II of this series will illustrate how these observed structural advantages drive excess returns, and Part III will outline how 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

• Capital Availability: The size of the potential investment opportunity set compared to the amount of capital chasing those opportunities has historically been mismatched in the small buyout market. Large market funds dominate the amount of capital raised in the private equity industry and fight over a limited set of target investments. The lower middle market is fragmented and, while there are more private equity firms, the number of potential deals is exponentially larger and continually growing.¹
• Valuations: Valuations in the lower middle market have historically been structurally lower than they are for larger deals providing managers with the ability to obtain higher valuation multiples at exit when these companies scale.
• Sale Processes: Private equity managers in the small buyout market have historically been able to acquire companies at a higher rate outside of formal competitive processes when compared to larger market deals, providing the opportunity to reduce market efficiency and lower entry valuations.
• Leverage: Lower middle market transactions have historically used significantly less leverage. Although debt is part of the return equation, the need for leverage has not driven returns in this part of the market.
• Opportunities to Create Value: Companies in the small buyout market are typically less polished and have historically provided more opportunities for private equity managers to add value than those larger companies already professionalized and at scale.
• Achieving Growth: Smaller companies are easier to grow and we have seen growth rates in both revenue and EBITDA decrease as company size goes up.
• General Partner and Limited Partner Alignment: Private equity managers of small funds targeting the lower middle market are believed to be more aligned with limited partners as on average they make less per partner in management fees and are highly incentivized to maximize returns to generate carried interest.² Capital in larger fund sizes generally scales at a far higher rate than underlying expenses and resources of the manager and thus, in order to produce the same carry dollars per partner, large funds do not need to produce nearly as high a return.

To read Part I, 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. 1. S&P Capital IQ. 2. 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.