A long time subscriber recently sent me the Global Private Equity Report by Bain Capital for 2015. Which should spur on a conversation of what is happening with private equity and how it affects us LBO buyers in smaller markets. Let me simplify what should be a complicated subject.
The theme of the Bain report is “capital superabundance”. Which actually could have been the theme going back 25 years to when private equity gained traction in the early nineties. Too much capital is always a problem, but probably never more so than now. Going back in time one can find dozens of examples of too much capital chasing too few deals. When this happens, and it has happened quite frequently in the last century, downright weird things happen and high finance gets their hands slapped for having too many tentacles in the cookie jar.
The most obvious result is that real estate values go up too fast as it happened in the eighties, nineties and just prior to 2008. The stock market gets overvalued, bubbles burst, the IPO market is overplayed and craters. Commodity prices go nuts, new investment vehicles are created for all the money that sits around. Capital abhors a vacuum and thus it seeks to find ways to invest itself, thereby getting itself into trouble like an errant child. So wall street and off wall street companies seek to find new ways to channel capital. Hedge funds aren’t sure whether they are investment managers or PE firms and will do any deal that they figure makes them money. Junk bonds get back in favor, REITS, securitized loan programs and, yes, subprime loans being the poster child of bad investments. All these things and more typically blow up in our faces every ten years or so. Like clockwork.
Private Equity is no different and seeks to deploy the overabundance of capital even though it can’t. PE firms have often had to return their capital to investors if they can’t use it. Funds must remain fully invested to get the proper returns. Venture Capital firms are forced to invest in lousy deals in order to get to the good ones. Too much capital forces PE firms to seek out new markets and alternative investments to continue to grow. They have to go overseas, get into risky deals, get into uncharted industries, etc.
Right now, following five years of growth from the great recession, the stock market has performed, the economy has been stimulated, interest rates are down and capital has accumulated on a global scale. The good news is anyone should be able to raise capital for a good deal. The bad news is that too much money is snapping up all the good deals. Of course PE firms generally do not reach down to our level and buy small companies. Indeed there are exceptions, such as the periodic roll-ups of mom and pop industries, which doesn’t always work. PE can buy deals down below $5mm in EBITDA and even further down the ladder for add-on deals. But when we talk about $2mm or less we are still by ourselves in a huge small market.
So what does this mean to the small buyer? Well, as all this capital gets near us we can feel the effects. When we were doing LBO’s years ago, the competition was less. Thus the higher end of our EBTIDA range is more recently getting competitive and the deals may command more capital to meet that challenge. My message to my buyers is this. Practice your road show because you will want to get into the game of raising capital. The capital sourcing is easier today than it was ten years ago and there is more money now than ever. Once you get the hang of developing capital sources your deal size will increase as well. So while you may want to do your first LBO by yourself on a smaller deal, keep in mind that there is much bigger game down the road and you should gear up for that right now.
