The Lower Middle Market

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The Lower Middle Market: 3Q22

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The Lower Middle Market: 3Q22

Daniel McKeon
Oct 3, 2022
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The Lower Middle Market: 3Q22

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Happy Monday and welcome to this quarter’s edition of The Lower Middle Market. We’re the only news source tracking lower middle market M&A. Our goal is to keep you up to date on what’s happening in the market by highlighting the latest news, transactions, and activity.


Revisiting Search Funds in the Lower-Mid Market

We recently came across an article on search funds from Timothy Goddard of Corum Group. Timothy provides a good sell-side perspective on both the benefits and downsides of dealing with search funds.

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The Good:

  • Lots of capital in the market with approximately $6.9B of equity value that was generated through search funds since 1984

  • Search funds tend to be fast responders and more flexible than other buyer types

  • For founders and CEOs concerned with legacy and the future of their business a search fund can be a great match

  • The key metric in the success of a search fund is a fit between the company and the searcher

The Bad:

  • The proliferation of search funds has added to the signal-to-noise ratio when it comes to managing the M&A process

  • They can lack the industry expertise, ready capital, and clean structure to make a deal feasible

  • You tend to have to sell the company twice - first, the searcher, then their investors

The Ugly:

  • A longer and more complex due diligence process with the search fund and their loan partners needing time to diligence the agreement and the company

  • Search funds only have to do one deal meaning there are fewer incentives for bad behavior versus a private equity group that can’t afford a bad reputation

The article closes by mentioning that on net, it is worth including search funds in the M&A process. A search fund that matches the owner’s vision for their company can be a great fit, especially if they also bring sector experience, technical expertise and ready access to capital. On the ready access to capital part, we’d recommend looking into the difference between a self-funded search fund and a traditional search fund, as they are often conflated.

You can read the full article by clicking here.


Compounding Capital with Will Thorndike

Will Thorndike, founder of Housatonic Partners and author of The Outsiders was recently on the Invest Like the Best podcast with Patrick O-Shaughnessy. It’s a great listen if you’re interested in the intersection of search funds, long-term holding periods, and lower middle market private equity opportunities.

Some of the highlights worth sharing:

  • Over the last 10 years, software has become the single most popular industry for search funds

  • There’s disproportionate power in truly low churn businesses (defined as <2% customer churn)

  • Search for businesses with high returns on tangible capital

    • Defined as EBITA(1-tax rate)/(Net Working Capital +PP&E); looking for 20% or better

  • Retaining the ability to do small acquisitions really well instead of solely focusing on larger deals turns out to be a common thread across really long-term serial acquirers

  • The Rule of 10 for serial acquirers

    • Defined as Gross (Logo) Churn + EV/EBITDA; The lower the better and ideally under 10

You can find out more about Will by checking out his new podcast 50x or by visiting Compounding Labs, his new firm.

Transactions Happened

LLR Partners was the most active investor in the quarter. The firm participated in 12 investments ranging from its medical practice platforms to software and financial services. Investments included:

Medical Practices 🩺

  • WellNow Urgent Care scooped up Physicians Immediate Care Link

  • Eye Health America acquired Bradenton Eye Clinic and West Georgia Eye Care Center Link

Hospitals & Health Care 🏥

  • Revecore acquired revenue cycle management companies Kemberton and Cura Link

Financial Services 💰

  • Celero Commerce acquired Community Bankers Merchant Services Link

  • ParkHub acquired Fuzse Link

Software 💻

  • DaySmart acquired TeamUp Link

  • Edlio added on SchoolInfoApp Link

  • Growth investment in AI-driven transportation management platform, PCS Link


Construction isn’t the first industry that comes to mind when thinking about lower middle market private equity as it’s often driven by cyclicality and high cap-ex requirements. However, construction-related deals led the way in our 3Q22 deal tracker.

Construction-related deals for the quarter include:

  • Huron Capital’s Pueblo Mechanical acquired ProCraft Mechanical Link

  • Copley Equity Partners invested in Roof Depot Link

  • Mill Point Capital acquired Construction Resources Link

  • Gladstone invested in Viva Railings Link

  • Northstar and Soundcore invested in ACI Asphalt & Concrete Link

  • O2 Investment Partners-backed Capital Construction added on Linear Roofing & General Contractors Link

  • Compass Group Equity Partners invested in Florida Energy, Water, & Air Link

  • Southfield-backed Milrose acquired Masterplan Link

  • Argyle and Celina Capital Corp acquired TRS Components Link

Fundraising

Peterson Search Partners Raised $100 Million for Fund II Link

Twin Bridge Capital Partners Closed 5th Fund at $880 Million Link

Shore Capital Partners Closes Over $290 Million for Food & Beverage Fund II Link

Crossplane Capital Closed Fund II to Target LMM Industrial Companies Link

Argosy Private Equity Closed 6th Fund at $422 Million Link

Resolute Capital Partners Announced Close of Fifth Fund at $405 Million Link

McNally Capital Raised $150 Million for Fund II Link

Kayne Capital Closed $600 Million in Latest Growth Equity Fund Link

Bow River Capital Raised $590 Million for Fund III Link

Turning Rock Partners Closed Fund II Link

RiverGlade Capital Raised $453 Million Fund II Link

HCAP Partners Announced Final Close of New $353 Million SBIC Fund Link

Other Stuff

Inside Eastman Kodak’s Private Equity Program, Where Lower Middle Markets Reign Supreme Link

Franklin Foster on Essex Bay Capital’s Launch Link

Emerging Manager Spotlight: Jack Waterstreet of Sky Island Capital Link

Emotions Run High In M&A, But Effective Communication Keeps Deals On Track Link

When To Leave Leadership Behind Link

Sell-Side M&A Reaches New Heights as Buyers Remain Picky Link

Pitchbook’s 2Q22 Middle Market Report Link

Private Equity Q&A with Altera Private Equity Link

The Intersection of Boring and Complex as an Investment Guide:

Twitter avatar for @patrick_oshag
Patrick OShaughnessy @patrick_oshag
Charlie Songhurst on why “boring and complex” companies may offer the best returns
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7:40 PM ∙ Sep 21, 2022
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