The current valuations and investment potential for sub-$100M revenue companies is frustrating private equity (capital) investors. There are a number of market and transactional factors contributing and, at the surface, the market factors may be perceived as uncontrollable. But there are ways to control, choose or transform the market participation and strategy one takes. The current market does make transactional factors harder to control and usually this is discovered too late.

A financial investor in the private capital markets must evaluate and model on a standalone basis. Market competition is forcing investment premiums up in order to win and have the ability to deploy capital. While not the approach and environment that a general partner (GP) or limited partner (LP) prefers, they still have value creation and cash driving expansion possibilities. The financial buyer can entice sellers and intermediaries (to some level) with an approach that creates focused scale and operationally driven opportunities. So what can an investor control?

Inch Wide and Mile Deep

Generalist funds may have had business development success and prior fund returns. But the marketplace is more difficult now. They should focus on industries where they have prior experience or in areas of specialization. Case studies, comfort, executive depth and partner experiences can guide choices for perhaps up to four or five areas/segments. Each could then have up to four or five more sub-niches within. A focused strategy typically builds enthusiasm, heightening market visibility and analyst attention. It is often lucrative to sell to strategic buyers. So why not incubate the companies?

Build It and They Will Come

With the identification of markets and segments, a deeper dive into the PE investor and strategic activity may be warranted. If the analysis identifies activity, repetition and acquisition patterns, an investor should reverse engineer the process by developing relationships early - learning about their corporate development, strategic intent and focus. The PE firm and its business development teams must outwardly market, updating their contacts and touch points regularly. By doing this, sellers on the radar of strategic investors can create desired inbound marketing results.

The Transactional Dilemma

While it may be hard for investors and buyers, competition is fierce for intermediaries such as investment banks. Lower retainers and incentivized back end success structures lead to broad auctions and sales to strategics. Additionally, the time, cost and outreach to the right strategic investors by an intermediary can create enough auction without introducing financials and all that goes with the current market. This may lead to an easier transaction with a buyer flush with cash, and with less interest in management contracts and ongoing involvement or seller notes.

With this dynamic, what investment bank would not manage a sell side like a buy side if they intimately know and follow a market with transaction history within it? Managed process, expected valuation and transaction probability can occur at higher than PE comfort levels with the valuations. The private capital investor with focus and expertise can stay relevant with investment banks and in such processes. If they behave like a hybrid of a private equity/strategic model, along with the financial advantages offered to the seller, a higher probability of success is possible.

Speed

Deal closing in private equity can drag on if it’s an auction of financial participants waiting to see who gets the shot at buyer’s remorse. Transaction participants have resources and can move processes. The motivated buyer with a post-close strategy formation will win. Strategics will follow industries, company participants of interest, technology and targets much more closely than PE does. They know the price ranges for assets and track and stalk their targets. In transactions involving a limited auction of strategics, the field self-thins quickly to a sale. This is where focus, along with executives forming their strategy early on, has significant advantages. It is quicker and easier on all fronts for the investment bank. The questions and diligence of the strategic buyer is laser sharp, and the transaction is closed more quickly. Repetition has its advantages.

Synergy Trumps Buy and Build When PE Doesn't Have a Platform

The number one add-on strategy for PE is using a buy side bank while a platform is closing. This gives speed and scale since strategics have narrower ranges and experiences while PE is always in buy and build mode and focused on the banker relationships for the platform. A revision in approaches from buy and build to “think like a strategic in sourcing and building” may be the only way to play and beat the strategics. It may be the definitive strategy in a highly competitive, overpriced market with limited auction opportunities for financial investors.