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Private equity. It is a broad term used to describe the funds that invest in businesses large and small. While the media generally focuses on big players such as KKR and the Carlyle Group, there is an entire ecosystem that specializes in small-to-medium sized businesses. This is known as the lower middle market. Here is an overview of how these funds work.

What Do Investors Look For?

In general terms, private equity (PE) funds that specialize in the lower middle market tend to work closely with the business owners to help them develop and execute a growth strategy. This is especially important for smaller companies since they can either grow into larger businesses or their growth will garner interest from the leaders in their industries.

There are also several challenges which are specific to companies in the lower middle market. These include size, resource availability, and the ability to deliver during periods of rapid growth. These challenges differ from those faced by larger companies, and it is a reason why investors in the lower middle market are specialists.

Specialization is important for small-to-medium sized business owners who are considering taking on a private equity investor, since it means that a fund will understand the specific challenges they face and will have experience in driving a growth strategy forward.

Why Choose Private Equity Over a Strategic Buyer?

The answer is simple, strategic buyers are looking to invest in your business because of a strategic fit for their business; while a PE fund is interested in your business because they see an opportunity to drive up the value. This allows business owners to get the cash they need to grow today, and a larger check tomorrow when it is time to exit.

But don’t forget, choosing a PE fund over a strategic buyer is not without its risks. For example, the market could turn against you and a failure to execute on a growth plan will have a dramatic impact on your long-term plans. This is not to say that every company will fail to hit its targets, but sometimes goals can be impeded by elements which are beyond your control.

3 Principles for Success

Just as PE funds have their own guidelines for which companies to work with, so should business owners set guidelines for which funds to partner with. Doing so will not only help manage expectations post-investment, but it will also help to guide the decision-making process when considering an offer.

The first principle is the team that the fund brings to the table. In many ways, this is even more important than the money they invest, as it is the knowledge and experience of the team that will help bring your company to new levels.
As such, one of the things you want to do before the investment occurs is get to know the team. This will give you a chance to better understand them, their experience and, most importantly, whether you will be able to work with them.

The second principle is the focus of the fund. In the lower middle market it pays to specialize. So, if you are talking to a fund that is trying to cover dozens of industries or corporate situations, this is a potential red flag. Sure, the larger funds have billions of dollars and can afford to take larger risks, but the funds which invest in the lower middle market need to have laser-like focus to achieve their goals.

The last principle is that any investor should be able to offer a clear vision of the potential exit strategy – including likely buyers. This will help give you and your team the confidence needed to ensure that all your hard work will be for a payday soon.

In addition to the vision, you might also want to talk to some of the fund’s current and former portfolio companies. This will give you a better feel for how things worked out.

Contact the team at Beal Business Brokers and Advisors to see if private equity investment might help you achieve your plan for growth.