Trends Watch: February 16, 2017

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks to Ben Moe, Co-Founder and Co-Managing Partner of Osceola Capital Management.

What is your outlook for private equity and more specifically lower middle market buyouts?

Our viewpoint is unique in the private equity space in that we limit our focus to what we call “micro private equity,” zeroing in on ripe and ample opportunities in the lower middle market. This is a highly underserved space. In this sense, we’re somewhat insulated from the overall private equity market climate, which should nevertheless remain highly active for the next several years with continued low interest rates and a high level of committed capital.  Larger private equity performance tends to be cycle-dependent with more efficient information, sophisticated buyers and sellers, and more aggressive leverage. Larger investments made in peak cycle periods can have less margin for error in reaching appropriate risk-adjusted returns. 

The lower you move down the market in transaction size, the smaller the impact of cyclical trends.  In the lower middle market, a solid cash-flowing business bought at a reasonable multiple with modest leverage is typically well equipped to weather any storm, and is therefore well positioned to take advantage of additional acquisitions at discounted prices during a downward cycle.

Where are the greatest private equity opportunities and what are the biggest hurdles?

The greatest opportunities lie in fragmented industries that offer significant organic growth as well as subsequent acquisition opportunities, most notably in industries where scale can create barriers to entry and market differentiation.  Specifically, we like service businesses that represent clear horizontal (expanded services with existing clients) as well as vertical (upstream or downstream) growth opportunities.  Business-to-business companies that can offer significant client savings such as outsourced services or resource pooling tend to fare exceptionally well in a downward cycle as their clients are more motivated to seek out ways to maintain profitability.

The biggest challenge for private equity is sourcing and executing great acquisitions at reasonable prices in a heated market.  We have found that we can overcome this by focusing on the smaller end of the industry.  Our key hurdle then becomes the efficient allocation of time and resources given that information is inefficient and the amount of capital put to work in each transaction is smaller.  We need to be diligent and creative in how we source acquisition opportunities up front to ensure we are seeing more businesses of better quality with a higher percentage chance of being something of interest to our strategy.

What keeps you up at night?

Given the fertile lower middle market and sheer number of opportunities, maximizing the business acquisition process, especially within the ecosystem of fragmented industries from which we source, keeps us up at night.  Regulatory risk and any ripple effect of volatility is also a universal concern that can occasionally make even a veteran private equity investor wide-eyed in the wee hours.