Which does the European mid-market favour?
For private equity firms, this represents a significant opportunity, as it opens up a new market made up of companies who would not traditionally have considered private market funding.
When previously their bank was their first port of call, these companies now face more complex choices, not least deciding whether to work with generalists or specialists who offer sector- or strategy-focused funds and other differentiated offerings.
What are the merits of these two options?
Jim Strang, Managing Director and Chairman, EMEA at Hamilton Lane underscored that market dynamics have changed, with smaller funds designed for smaller-sized companies, and the need to match this shift in PE strategies:
“The world is a pyramid of opportunities, and there are lots and lots of small things and not very many big ones. And if you're fishing in that very rich pool of small companies, then that you have a lot to pick out. And you've got a lot of different choices to make.”
But the approach to value creation will be very different - and obviously not the same as if you were building a consumer internet disrupter for example, Strang explained. Whether you go down that route is down to two factors, he added.
“I think about it as a little ‘lozenge’ of confidence and competence. How much confidence do these GPs have in what they're doing, as in, conviction? And then how much competence have they got to be able to do it?”
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Therefore, GPs need to show relevance to the marketplace and proof of their experience to convince LPs and target companies alike.
“It doesn’t have to be a sector-based strategy, but you do want to have some sense of what you're going to be backing, and why and how it's relevant for the market space that the GP operates within,” Strang concluded.
As François Jerphagnon, Head of Expansion at Ardian, pointed out that being a generalist is not about “knowing everything about everything.” Sectoral knowledge, for example, is definitely part of the process for a generalist, too. Only the approach is different.
“The point indeed is that you have to work on investment opportunities early on. You have to work on your angles and clearly, sector knowledge is part of it.”
The question is whether to draw on an internal team or source the required expertise from outside.
“I don’t know why I should tie myself to specific sectors, looking at the current market, and especially these days where we see a polarization of the market,” he added. “The point is that there is a place for everyone.”
Why is it so important to be specialised? Jean-Marc Jabre, Co-Founder of Capital D, shares with us his insights.
Florian Schick, Managing Partner, at Bregal Unternehmerkapital, drew attention to the softer needs of potential investment candidates, which can also become a source of differentiation for a GP.
Many of the companies he deals with are German Mittelstand businesses who would not have considered working with a PE company in the past.
Like many mid-market businesses, their reason for changing tack is not only that their banks are backing off, but that they are also looking for more hands-on support for strategies such as international expansion or digital transformation.
“We looked a bit more closely and realised that these people speak quite differently about their businesses.”
Not only does working in this mid-market environment mean that a GP needs a regional approach, given that Germany is very decentralized. It also means the PE needs to give more consideration to the softer side of the negotiations.
Owners, said Schick, “want to feel that they leave their employees and the other stakeholders with a responsible partner. That means is that we often spend a bit more time with the head of sales, or talking to the CFO.”
These mid-caps want to sell to a PE company that matches their value set, which, in turn, can be a source of differentiation or specialism for a PE firm, he suggested.
In summary, there a opportunities and challenges aplenty for generalist and specialist GPs – with both having to demonstrate what will enable them to deliver the best returns to potential portfolio companies and LPs alike.