Investors Seek Small- and Mid-Market Private Equity Funds
Historically, private equity has been the leading source of capital to businesses as the U.S. economy recovers from recessions. According to the Private Equity Council, “Following the past five periods of negative economic growth in the U.S. (1974, 1975, 1980, 1982 and 1991), real private equity investment increased by an average of 94 percent during the initial year of recovery.”1 In addition, “The number of private equity acquisitions grew by an average of 55.1 percent in each of the five years following an annual decline in GDP.”2
According to BHA’s research, this pattern is evident in the current recovery. Comparing the number of private equity mandates for the first quarter of 2009 with the number for the first quarter of 2010, analysts saw an increase of roughly 15 percent.
More interesting than the increase in the number of mandates, however, is the significant interest in small- and mid-market funds. Looking at year-over-year statistics, in the first quarter of 2009, roughly 50 percent of investors BHA interviewed expressed interest in large-market funds. One year later, that number dropped to less than 40 percent. At the same time, more than 95 percent of investors expressed interest in mid-market funds and 70 percent voiced an interest in small-market funds.
Furthermore, less than 15 percent of the investors BHA analysts have spoken with this year have shown an interest in private equity funds raising more than $500 million. Conversely, more than 40 percent are looking for funds with $200 million to $500 million in assets, and 25 percent are seeking funds with less than $200 million under management.
It is not surprising that investors are flocking to small- and mid-market private equity funds since they have outperformed their large-market counterparts in the last year. What is surprising is that large-market funds have not adapted to the current trend.
A recent discussion with an analyst at an international fund of funds shed light on the situation. This analyst noted that after years of focusing on mega-size transactions, large-market funds lack the mid-market network and reputation necessary to complete smaller-sized deals. If the larger funds want to compete, they will have to significantly scale down operations and shrink fund size.
However, even after putting the proper infrastructure in place and changing their fundraising model, large funds may not find it easy to attract investors. BHA has received more than 400 private equity mandates since January 1, 2010, and more than 99 percent of investors told analysts that they either require or prefer experienced managers. Of these investors, only 30 percent would consider a first-time team and 60 percent would look at a spin-off.
Experience is paramount for investors when selecting a private equity manager, and that is not acquired quickly. While large funds are considering their options or trying to shift strategies, it appears that smaller, more nimble funds will capture more investment dollars.
1,2 Private Equity Council, “Summary of research findings,” May 11, 2010.