Private equity is enjoying the best fundraising climate in years, but some larger generalist firms have decided against raising new funds. As a result, younger general partners have been breaking away to launch the next generation of middle-market funds. Some have already succeeded in raising new funds, while others are still in the fundraising process.

On the whole, these newbie funds are smaller in size and more narrowly focused. And limited partners are ponying up. According to Coller Capital's Global Private Equity Barometer, 70 percent of PE investors in North America intend to invest in first-time funds between now and 2016. This is a dramatic shift from recent years. In 2013, first-time funds accounted for just 7 percent of funds raised by private equity firms, according to Coller.

Here's a handful of nascent middle-market firms we're tracking closely.

Blue Sea Capital

With middle-market private equity firm Brockway Moran & Partners not raising another fund, a handful of partners have spun out to raise a new, smaller, more focused fund. In June 2014, the new firm, Blue Sea Capital, closed its first fund with $327 million.

"A number of the founders worked together at Brockway Moran for many years," says Peter Brockway (pictured), who has taken a senior adviser role with Blue Sea. "The working relationships go back over 15 years, and we have a common vision about creating value and have chosen to focus on three verticals - aerospace and defense, healthcare, and industrial growth opportunities."

James Davis and Richard Wandoff, Blue Sea founders, are former Brockway Moran partners. Mark Silk, also a Blue Sea founder, is the former president and CEO of Tri-Star Electronics and Integrated Aerospace, which were both Brockway Moran portfolio companies. In fact, eight professionals at Blue Sea worked with Brockway Moran at some point in their careers.

Palm Beach, Florida-based Blue Sea targets lower middle-market platform investments with up to $30 million in Ebitda, committed existing management teams and opportunities for expansion.

The firm's investors are typical limited partners, including funds of funds, pension funds, endowments and family offices. The firm intends to be deeply involved with portfolio companies and invest only in companies where the founders feel they can create a significantly different asset from the one they originally bought. "The team has always been very involved with the companies it buys, and works to differentiate and transform the companies it owns. With the high prices today, there is no doubt that you have to be active and effective partners to make compelling returns," says Brockway.

To date, Blue Sea has invested in two companies, DDS Lab and SunVair Aerospace Group. DDS Lab is a Tampa, Florida-based dental company that sells custom dental prosthetic appliances to dentists across the U.S. SunVair, headquartered in Valencia, California, is an independent Federal Aviation Administration repair station and provider of landing gear overhaul and component repair services for commercial and military aircrafts.

Lariat Partners

After spending 12 years at Denver-based KRG Capital Partners, Jay Coughlon (pictured) left because he wanted to get back to basics. Over the years, KRG has grown from a middle- market generalist buyout shop to a larger middle-market fund. Its most recent fund is a $1.96 billion opportunities fund. Today, it is widely speculated that KRG will not be raising another fund under the KRG name.

While Coughlon did not comment on KRG's future, he was certain that he wanted a more focused approached to investing and launched Lariat Partners in January 2013 with Kevin Mitchell, who was a managing partner at RedCloud Capital, a fundless sponsor firm focused on the lower middle market.

In July 2014, Denver-based Lariat closed on its first fund, Lariat Partners Fund I, LP., with $118 million. The firm's investments target consolidations, consumables, recurring revenue businesses such as repair, replacement, retrofit and regulatory.

"We wanted to focus on deals that minimize cyclicality. These deals may not be as sexy as some other types of deals, but they have more consistent growth rates and exit multiples," says Coughlon. "We invest in entrepreneurs that lead steady businesses in fragmented industries."

The fund will make only five platform investments and a number of add-on acquisitions to each platform. In fact, as the firm hit the fundraising market, it had already identified three of the five platforms it was interested in investing in. The fund will target companies with Ebitda of $2 million to $20 million, with its sweet spot below $10 million.

Four groups account for about 75 percent of Lariat's fund. The firm's limited partners are mostly funds of funds.

"It helped with our fundraising that investors could see the three deals we already had in hand," says Coughlon.

To that end, the firm has acquired Ecoserve, Subsea Global and Northern Seed. Ecoserve was formed by merging Newpark Environmental Services with Offshore Cleaning Systems. The Lafayette, Louisiana-based company is an environment cleaning and waste disposal provider. Subsea Global is an underwater repair, maintenance provider for vessels and ports throughout the world. And Northern Seed is a Butte, Montana-based distributor of certified seed and seed treatment services to growers in Montana. Northern Seed has completed two add-on acquisitions with the buyouts of WestFeeds and Montana Seed and Grain.

ParkerGale Capital

"I think you will see a lot more spinouts now that the private equity industry is starting to get more focused," says Devin Mathews (pictured), a founder of ParkerGale Capital. Mathews and four other partners from the technology sector team at Chicago Growth Partners founded ParkerGale after CGP decided not to raise a third fund earlier this year.

ParkerGale is targeting $200 million to invest in buyouts of tech-enabled service companies with heavy operational needs. "LPs are now looking for much tighter focus. A lot has changed since the downturn, and we can offer a sector fund with a long track record of investing in technology companies," says Mathews.

Although the Chicago-based firm hasn't officially started fundraising yet, it does have capital available to complete deals on a one-off basis. Fundraising will probably start by year-end, and Mathews expects that limited partners will be comprised of endowments, foundations and fund of funds. "Although we are a first time fund, most of us have worked together for 10 or more years. We think given the success of technology buyouts over the past several years, a lot of investors are looking for this type of strategy," says Mathews.

The firm will target U.S.-based companies with $5 million of Ebitda and be engaged with the company after the transaction. Additionally, the firm will buy only from founder- owned companies, not from venture capital firms or other PE firms. ParkerGale also expects the company's founders to invest alongside the firm.

Shore Capital Partners

Launched in 2009 in the face of the recession, the founders of Shore Capital Partners knew it would be hard to raise a first-time fund. Instead, the partners started the firm by completing transactions on a deal-by-deal basis with no formal fund. The four founding general partners came from four different firms including Valor Equity Partners, Water Street Healthcare Partners, Wind Point Partners and Henry Crown & Company, a family investment office.

"Our view of the world is that 25 years ago, a big private equity fund was $500 million, a medium size fund was $200 million and a small fund was $50 million to $100 million. The private equity asset class in this time period did well versus other asset classes, attracted more capital and the successful managers raised larger funds. The result is that today, a large fund is $3 billion to $4 billion and small fund is $300 million to $400 million. These small funds today can't afford to write $10 million equity checks for new platforms, as they need to deploy more capital-per-deal," says Justin Ishbia, a founder of Shore Capital.

As a result of firms moving upstream, Ishbia and his team believe there is a void in investment opportunities for microcap companies. The firm focuses on microcap health care companies-those with $1 million to $5 million of Ebitda.

The Chicago firm went on to complete five platform investments and 10 add-on acquisitions on a deal-by-deal basis over a four-year time period and produced successful returns. For example, its 2012 physical therapy platform investment, Excel/MRS, produced a 139 percent gross internal rate of return, while its 2010 home infusion platform, Sirona Infusion, produced a 67 percent gross IRR. These deals had 20 to 40 investors each.

In May 2014, the firm successfully closed its first institutional fund with $112 million. "We were able to get our previous investors to come into the fund in addition to many new institutional investors," says Ishbia.

Within the health care sector, Shore Capital invests in companies where there are three or four big players and lots of smaller players in the space so there is opportunity to scale. For example, Clearpath Diagnostics was a smaller player in the diagnostic arena located in Syracuse, New York. The major players include Quest Diagnostics (NYSE: DGX) and Laboratory Corporation of America Holdings (NYSE: LH). Over its investment period, Shore Capital grew Clearpath into Connecticut, Massachusetts, New Jersey, lower New York, Pennsylvania and Vermont.

"We think we have a great opportunity here to partner with microcap businesses, help them grow organically and inorganically, resulting in leading regional companies," says Ishbia.

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