The Riverside Co.’s Greenphire exit, one of the private equity firm’s largest, is the latest anecdotal evidence demonstrating that the wave of PE valuations is breaking on middle-market shores. The lower middle-market firm landed the sale to Thoma Bravo after steering Greenphire to an 8-fold revenue increase over seven years.

But how typical is the deal for middle-market PE firms? Whether blockbuster deal values translate into higher middle market multiples could make the difference between higher capital inflows and the status quo.

Signs of frothy financial sponsor valuations are evident across sectors. Refinitiv finds that the average private equity takeover reached all time highs at 13.2x enterprise value to earnings before interest, depreciation, and amortization in 2020. That’s up slightly from 2019, but is noticeable given valuations’ resilience in an act-of-god market environment. 

That trend is expected to continue higher as well. Financial sponsors expect valuations to increase this year, according to a recent BDO survey of private equity and venture capital managers. General partners told BDO more financial sponsors are getting off the sidelines, creating more robust competition for target companies.

Taken together and the middle market begins to look like a more attractive place for limited partner funds. Higher deal values from larger funds usually accompany investor concerns that GPs will have trouble maintaining returns. 

The SRS Acquiom 2021 M&A Deal Terms Study shows a wide range of return profiles for those investments with a 2020 investment: PE exits averaged a 5.7x equity multiple that year, placing the buyers at the back of the pack despite participating in deals at transaction values closer to their rivals. See the variance in the chart above; the data set is of 1,400 deals with a private target from 2016 to 2020 on which the firm advised. 

There’s some evidence that froth might already be pushing limited partner assets into the middle market. Frazier Healthcare Partners’ managing partner Ben Magnano notes an uptick in interest from sovereign wealth funds and foreign capital when his firm raised its $1.4 billion tenth fund, which closed yesterday. 

“Most of these groups think in long periods of time; for them a 10-year fund cycle is a blink of an eye,” Magnano said in an interview Thursday. “They say we want to be with you for 2 to 3 funds to avoid the vintage risk.” 

Soaring valuations in larger private equity funds might push capital into the middle market as investors seek to maintain returns, and that capital could well prove sticky as Maganano says. It bears watching, though, whether middle market deal multiples will spike as well, potentially reducing the asset class’ attractiveness.