Key Private Equity Trends in the Middle-Market

Analytics that reflect patterns of behavior are useful underpinnings upon which to make judgements about where institutional LPs and middle-market sponsors are headed. It is important, however, to view such analysis within the broader context of the alternatives industry or the markets generally. In that spirit, Sixpoint has relied on a combination of market research and first-hand observations to inform key private equity trends for the middle-market.

1. Market Top – The surge in capital commitments across private equity is a reminder of where we are in the PE life cycle. Independent sponsors are competing with established platforms, co-invest LPs are chasing deals and increasingly paying fees to have a seat at the table while funds left for dead are the now the phoenix rising. It is time to think about pacing, structure, strategy and downside to mitigate risk in a frothy market environment. LP-GP conversations around separate accounts, alternative fee structures, shorter investment periods and expansion strategies are increasingly a topic of interest.

2. Sector Focus vs Generalist Approach  Since at least the Great Recession, LPs have shown a preference for sector focused firms. The thinking goes like this: in a down market, your domain expertise and operating network enable you to better triage your portfolio companies. In an overcrowded market, however, query whether we begin to see a greater interest in (or case for?) the generalist investor. Given how rich valuations are today, it may be time for the model to evolve again. If you have only one tool, say a hammer, it means that you are going to use your hammer every time even when it’s time to turn the screw. A generalist approach may afford LPs the ability to move across sectors with a defined manager to find the best value. GPs should reconsider their strict focus and sector approach.

3. Valuations Given how rich valuations are, it’s time for GPs to own up and accept that in some scenarios they are simply “paying up” for assets. When you speak to LPs, remind them that the sole determinant of value is not only what multiple you pay, but what value you create and growth you expect. Paying 8x-9x for an asset with a strong growth profile or an ability to average down the cost with immediate add-ons or other value-levers is where the true embedded value of an asset lies.

4. Strategy & Structure – Another way to avoid the competition is to target smaller companies, employing a buy-and-build approach. There are still proprietary opportunities in the lower part of the middle-market and this is where some GPs are spending their time to avoid high prices. An alternative angle is to be flexible with the structure used to access these investments. The clear majority of buyout funds are still looking at taking majority positions, but many are starting to pull the trigger on minority positions IF there exists a clear path to control.

5. Spinning It’s not just for SoulCycle enthusiasts anymore. We have frequently discussed spin-outs and spin-ins in past issues of 60 Seconds with Sixpoint, so we would be remiss not to mention the wave of departures from mega funds over the past 18 to 24 months. Many of these spin-outs have been warmly received by the institutional market, further encouraging the trend. Spin-ins are also becoming increasingly popular, sometimes as a way to combat spin-outs. The best performing sponsors are being rewarded with LP commitments for their flagship funds as well as their more newly established strategies. Sixpoint frequently works with cornerstone LPs seeking to back new managers.

As the market continues to evolve so does your approach. GPs that remain dynamic and flexible in meeting LP demands and keeping up with market trends will both outperform in the current environment and be best positioned to weather the downturn – whenever that may arrive…

*Source: Pitchbook

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