From PwC’s perch at the nexus of numerous private equity-related transactions, the asset class has gone mainstream. “It’s always been a very consistent outperformer in the market and everyone wants a piece of it,” U.S. practice leader Manoj Mahenthiran tells Mergers & Acquisitions. One implication of the asset class’ widespread adoption is that strategies typically associated with large funds can migrate to the middle market. Let’s take a look at which.
But first a bit of context: signs of the industry’s move into the mainstream are numerous.
“A lot of firms raised money during the pandemic without meeting people. It saves time and reaches a larger pool of investors,” says Mahenthiran. “Some funds were reluctant to sign an equity check without at least one meeting, but that changed.”
The same investor interest that’s given private equity record amounts of dry powder has also lent credibility to new fund managers. Deal teams newly spun out of established funds are attracting significant capital based on their track records and feverish demand.
“They’re raising their first time funds at staggering levels. It’s unheard of,” Mahenthiran says. “I don’t remember another time a first fund could raise $1 billion; now it’s standard, even $2 to $3 billion.”
Even the SPAC phenomenon can partly be attributed to interest in private equity, argues Mahenthiran. Shut out of a new fund? Back a blank check company that replicates the buy and build strategy of a traditional financial sponsor instead.
The very definition of the ‘middle market’ has changed thanks to the influx of interest and capital. With this shift, could smaller private equity firms adopt other changes?
Private equity’s recent pivot toward permanent capital could eventually find a home in the middle market. While middle market firms don’t face the pressure to post consistent quarterly returns like the publicly traded PE shops, other demands are the same: competition from a large array of funds, potential tax reform, record levels of dry powder that needs to be deployed.
One option on the menu could be insurance acquisitions to capture the recurring fees from a source of permanent capital. See Apollo‘s acquisition of Athene, for example.
“It’s becoming harder to make the outsized returns they delivered, so middle market funds do need to look at alternative ways to bring in income,” Mahenthiran says. “That’s when you’re going to see what we historically saw as a middle market fund raising a second fund to do smaller deals where they maybe have more leverage to get the returns they’re used to.”
The pandemic has accelerated trends that were already playing out previously, Mahenthiran says. Healthcare remains an attractive market as financial sponsors use data to drive efficiencies, though Covid has provided a springboard for firms to “double down” on behavioral health and telemedicine. Tech should also remain attractive.
Those trends could continue given the frenetic pace of the market. “The volume of deals has changed so much, every firm I know is inundated with deals,” Mahenthiran says.