For Some LPs, the Lower-Middle Market is Sexy Enough


The lower-middle market — that niche corner of the M&A landscape where price tags hover $250 million or less — has become a sweet spot for many limited partners, according to dealmakers at the AM&AA Symposium in Boston on April 3.

“LPs have shown a fairly explosive amount of interest,” says Brett Palmer, president of the Small Business Investor Alliance. They are beginning to recognize the lower-middle market as a more favorable place to source deals due to the sheer volume of transactions, steady results and higher rates of return, he explains.

Palmer spoke alongside fellow private equity panelists Jay Jester (pictured), managing director of Audax Group, and Jeffrey Kadlic, managing partner at Evolution Capital Partners, as part of a panel moderated by Kenneth Marks, founder of High Rock Partners.

The discussion aimed to show the buyout community that while deal flow is considerably down across the general M&A market, there is plenty of opportunity for financial sponsors to put capital to work in smaller companies that have generally been overlooked and underserved.

Indeed, much of the venture and private equity community would rather invest heavily in well-known markets such as Silicon Valley, whereas a successful janitorial business in Arizona would normally get dismissed by investors because “it’s not sexy enough,” Palmer says.

But a growing number of LPs are beginning to change their outlook, and private equity firms doing deals in this particular space may be on the cusp of major change.

Jester pointed to the success he’s had with Audax as proof. The Boston firm, which writes equity checks of at least $10 million in transactions valued between $15 million to $250 million, has been especially successful with its most recent fund raising efforts.

In December, Audax Private Equity Fund IV, managed to generate 25 percent, or $250 million, on top of the $1 billion target the firm originally set.

“We look at any situation where we can start with a platform, or buy and build opportunity,” Jester says, citing business services, health care, building products, medical devices and technology as some of the sectors in which Audax focuses its efforts.

Some LPs have taken notice because debt levels in the lower-middle market tend to be more consistent, Jester claims—a sharp contrast to many of the deals that are facilitated by bulge-bracket private equity firms.

Evolution Capital, Kadlic says, has found similar success investing as little as $2 million and $10 million in entrepreneurial businesses, or companies that aren’t yet independent of their founder.

While it takes the same amount of time to exit these smaller investments as it does larger ones, the hit rate of finding potential buyers is much higher, Kadlic adds. Pitch books for one of Evolution's portfolio companies were sent to 175 financial and strategic acquirers. Of that number, 35 groups responded, Kadlic says.

Sourcing deals this far down the M&A chain, however, is often laced with various challenges such as a lack of financial data to support industry trends, Kadlic says.

Also, advisers and private equity firms often end up working with family-owned businesses—a process that requires a different set of skills and negotiation tactics than they would need during a large leveraged buyout.

“You’re on the ground more in places like Louisiana and Arkansas shaking hands,” Palmer says. “It’s a huge cultural difference.”

But with more LPs looking to make commitments, “the upside is pretty darn exciting,” Kadlic says.

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