Alpha in Middle-Market

Alpha in Middle-Market

Key Takeaways

  1. Mid-sized private equity investments have generated outsized relative revenue and EBITDA growth.
  2. They need a unique strategy and approach to succeed in the dynamic middle-market landscape.
  3. Focusing on founder-owned or founder-involved companies can be a source of repeatable alpha, especially in 1826 Partners' ecosystem of entrepreneurs.
  4. Founder deals often have a unique and diversified set of value creation opportunities.
  5. Succeeding with founder investments requires the right culture, approach, and incentives.
  6. 1826 Partners leverages a decentralized ecosystem spanning Europe, the Middle East, and the USA, facilitating strategic partnerships, best practices, market entry, and maintaining a local presence with global reach.

The Middle Market: A Source of Unique Opportunities

In the past two decades, private equity (PE) has evolved from a niche asset class to a highly competitive field with diverse offerings for large-cap, mid-sized, and small-cap companies. Amid this growing competition, the middle market emerges as a differentiated source of alpha, especially for companies with founder involvement. However, generating alpha in this space demands managers with specialized capabilities, a rigorous due diligence approach, and a proven value creation playbook. These elements are crucial when partnering with entrepreneurs and business founders. 

Why Middle-Market PE is attractive

Private equity investments in the middle market have consistently delivered strong asset-level returns. The sector's appeal is evident from the vast supply of privately owned targets and the potential for outsized value creation. For example, at the end of 2022, approximately 660,000 firms in the U.S. had between 20-1,000 employees, representing fertile ground regarding the middle market, while the Swiss economy in composed by 600,000 SMEs.

Structural Features Enhancing Alpha Generation

  1. Significant Growth Headroom: Middle-market investments typically possess a small market share, offering ample room for organic growth through new customers, products, or markets. Mature market leaders, by contrast, have limited growth potential.
  2. Margin Expansion Opportunities: These companies often have significant scope to expand margins by scaling up to reduce vendor costs and enhance corporate efficiency as the business grows.
  3. Add-On Acquisitions: Operating in fragmented industries, middle-market companies can drive meaningful equity value creation through strategic partnerships or entering new markets. In more consolidated markets or new ventures, such moves are less impactful.

The Appeal of Founder-Involved Deals

As competition intensifies, we must identify and specialize in market sub-segments with the highest equity value creation opportunities. Partnering with company founders can provide a sustainable edge, as founder-involved investments often yield greater relative revenue and EBITDA growth compared to non-founder investments, especially where we align interests of all stakeholders.

Benefits of Founder-Involved Investments

  1. Lower Competition: Founder recapitalizations often involve bilateral negotiations or limited sale processes, reducing competition for each asset and allowing more time to assess the business and develop strong management relationships.
  2. Quick Wins and Professionalization: Founder-owned businesses offer greater opportunities to grow revenue, expand margins, and build teams in the early investment stages.
  3. Founder Enthusiasm and Loyalty: Founders typically exhibit strong loyalty to their companies, driving growth through solid customer relationships, identifying acquisition targets, and serving as ambassadors for future investors.

The 1826 Partners Difference

1826 Partners recognized a market gap and designed a decentralized business model catering specifically to SMEs. Unlike traditional private equity firms or large consulting companies, 1826 Partners is committed to supporting every company striving for growth while ensuring they remain fully independent. Our decentralized business ecosystem spans Europe, the Middle East, and the USA, facilitating strategic partnerships, best practices, market entry, and maintaining a local presence with global reach.

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