Investors Bet on Smaller Private Equity Funds to Break Deal Drought
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Private Equity Shifts Focus to Smaller Firms Amid Dealmaking Slowdown
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Investors are increasingly favoring mid-sized private equity firms, anticipating easier exits in a challenging market.Fundraising is down but middle-market firms are securing a larger share of commitments.
Dealmaking Downturn Drives Strategy Shift
Private equity investors are increasingly turning their attention to smaller firms, believing they offer a more viable path to exiting investments during a period of sluggish dealmaking. this strategy centers on the idea that underloved companies with untapped potential are more readily positioned for growth and eventual sale than larger, more complex businesses.
Gabrielle Joseph, head of client advancement at advisory firm Rede Partners, explained that these smaller firms are attractive as they represent opportunities to transform businesses not yet operating at their full capacity. “Investors are looking for a business not yet reaching its full potential,” Joseph said,as reported by the Financial Times on December 27,2023.
the global private equity sector experienced a decline in fundraising during the first nine months of 2023. Approximately $320 billion was raised, putting the sector on track to reach roughly $425 billion by the end of December. This represents a 28 percent decrease compared to the previous year, according to the Financial Times report.
Large funds have been hesitant to initiate new fundraising rounds due to challenges in selling existing portfolio companies and returning capital to investors. This difficulty in realizing returns has created a bottleneck, prompting investors to seek choice avenues for deployment.
Despite the overall decline, middle-market firms-those targeting investments between $1 billion and $5 billion-have secured a larger proportion of commitments. Pension funds and endowments are leading this trend, recognizing the potential for higher returns and more manageable exit strategies in this segment.
| Year | Fundraising (USD Billions) | Change (%) |
|---|---|---|
| 2022 (Estimate) | $590 | – |
| 2023 (Projected) | $425 | -28% |
The Appeal of Middle-Market Investments
Middle-market companies often present unique opportunities for value creation. They typically operate in niche markets, possess strong competitive advantages, and have the potential for operational improvements. Smaller deal sizes also mean less competition from larger funds and a perhaps faster path to exit.
Furthermore, middle-market firms often have more specialized expertise and a greater ability to actively manage and transform their portfolio companies. This hands-on approach can lead to significant improvements in profitability and growth, ultimately enhancing the value of the investment.