By: Bailey McCann, Private Equity Strategies
Sellers in the lower middle market are starting to get more optimistic, but potential buyers are still remaining cautious according to Dave Moylan, Operating Partner & COO at Yennai Capital. New York-based Yennai Capital takes control equity positions in small to middle market US businesses with $10-100MM in revenues. Private Equity Strategies spoke with him about what makes a company stand out and where he sees opportunity moving into 2014.
“There is a lot more deal activity right now, but the number of deals that are actually closing show that there is still a misalignment of expectations between buyers and sellers,” he says.
Part of this separation between buyers and sellers is based on the more nuanced view buyers are taking of the market overall. Potential buyers are looking at more than just balance sheet and management. “As we start digging in and focusing on companies we’re looking at regional risk, competitive risk, not just management teams,” Moylan says. “For example, if a company has one customer for 60% of the revenue, we have to look at that knowing on day one what will that mean for us, especially if that relationship sees some tension. We also want to look at how we can diversify away from being a single customer business.”
When firms like Yennai do look at management teams, chemistry and work ethic define that evaluation. “We want to see the whole team pitching in, it’s the same as the customer base, if it’s one person why is it one person doing all the work? What can we do then on day one?”
For the companies themselves going into these transactions, Moylan reports that entrepreneurs are better advised and more realistic than they were during the frenzied years leading up to the crisis. “Owners are getting a little more savvy about what they ask for, they don’t want the costs to be as high or the time horizon to be as long. They’re asking for other things too like greater tax efficiency and employment agreements.”
The lower middle market is starting to get crowded as more funds look for ways to deploy capital, and still find high quality companies. As a result, players in the space are starting to see valuations tick up, but potential headwinds, like Fed tapering could make those valuations more expensive. “Bigger funds are starting to look at this part of the market, and you’re seeing valuations reflect that. If they pay a 4x or an 8x multiple it’s not a big deal relative to the check size they are used to writing.”
Opportunities in this part of the market are also regionally driven. “We’re looking at places like the west coast. California is interesting because of the size of the economy and the evolving regulatory environment there. Similarly, the upper Midwest is offering some opportunities in oil and gas, those economies will have to look at infrastructure and sustainability going forward.”
Some cities in newly formed energy markets have capped local development as state and local governments look at how local infrastructure will be impacted. “If you bring in 20,000 people overnight around oil it makes for a big demand on local infrastructure. Those trucks are heavier so roads come into question, housing is an issue and the businesses that follow right away are often check cashers, nightclubs, and convenience stores. If we’re looking at companies in those towns we’re going to want to see what those governments do on the regulatory side and are there more sustainable businesses coming in. Is there a Wal-Mart? Or grocery stores? That can be evidence of a longer term play.”
This article was published in Opalesque's Private Equity Strategies our monthly research update on the global private equity landscape including all sectors and market caps.