Private Equity Investment: Ownership Transitions Fuel Opportunities For Smaller Deals

A surging tide of ownership transitions represents a major growth opportunity for Canadian private equity investors, especially at the lower end of the market. While Canadian institutional investors have largely withdrawn from smaller PE funds to move upmarket, PE funds and pledge funds have found new sources of capital through family offices and high-net-worth individuals.

These are some of the conclusions of BDC Capital’s and CVCA’s new report “Barriers to Private Equity Investment in Small and Medium-sized Businesses: Summary of discussions.” The report sums up the findings of three industry roundtables organized by BDC Capital and the Canadian Venture Capital & Private Equity Association (CVCA).

Sessions were held in Toronto, Calgary and Montreal to discuss challenges of PE funds focusing on small and mid-sized companies amid today’s demographic and industry trends.

Major growth opportunity for PE investors

PE investment activity has rebounded strongly in recent years, with $28.2 billion in deals in 2017, up from just $6 billion in 2009 during the global financial crisis, according to the report. The demand for PE is expected to keep growing as the baby-boom generation of entrepreneurs reaches retirement age and seeks to sell their businesses, often to non-family members.

As many of 67,000 companies could be sold to non-family members within five years, according to BDC projections. Yet, the number of Canadian PE deals totaled just 603 in 2017. As a result, transitions could represent a major growth opportunity for PE investors.

Fundraising for small PE funds seems to have become more difficult over the last decade as large Canadian institutional investors withdraw from the segment in many regions. Funds smaller than $100 million comprised only 11% of all Canadian PE funds raised in 2015 and 18% in 2016, down significantly from over 50% seen in most years from 2008 to 2013, the BDC report says.

These needs and opportunities are top of mind for roundtable participants. Here are some of their conclusions:

1) Shortage of institutional capital

Participants largely agreed that it is much harder today than 10 to 15 years ago to raise Canadian PE funds smaller than $150 million. Large Canadian pension funds no longer invest in this market segment as limited partners. There are few other actors in this space, such as smaller pension funds, funds-of-funds and university endowments.

2) Growing demand for small PE investments

Ownership transitions are a large, growing opportunity for PE investment. But participants say deals in this area can sometimes be challenging. The main obstacle to a successful transition is not availability of capital, but rather the emotional readiness of the owner to sell, the company’s suitability for sale and difficulty matching sellers with the right buyers.

Some participants said minority investments such as BDC Capital equity offerings could be a good solution, helping to prepare for long-term transitions and playing an important role in intergenerational transitions. As such, BDC Capital’s Growth Equity team is an active minority equity alternative to buy-out funds.

3) Needs at lower end of PE market

Due to reduced institutional capital in this segment, few private and independent PE funds are looking for opportunities below $15 million to $20 million in enterprise value.

In recent years, however, the number of pledge funds—and to a lesser extent, search funds—serving this end of the market has grown significantly. These funds are financed mainly by family offices, entrepreneurs and high-net-worth individuals.

4) Emergence of pledge and search funds

Pledge and search funds have played an increasing role at the lower end of the market. Although they are less scalable due to limited access to stable pools of capital, they represented the majority of private sector participants in the Calgary and Toronto roundtables.

The increasing involvement of family offices and entrepreneurs through pledge and search funds has many benefits for business transitions, including:

  • They are more open to first-time fund managers and giving them the benefit of the doubt.
  • They are more agile investors than larger funds because they can make quicker decisions and have less stringent reporting mechanisms.
  • They may be better at educating entrepreneurs about transitions and better adapted to smaller companies.

Capital needs differ among regions:

  • Toronto: Roundtable participants in Toronto said they saw no shortage of capital in the market, with pledge and search funds filling the gap. They said BDC Capital could help the market by acting as an anchor investor in small PE funds.
  • Calgary: Participants also mentioned a surge in pledge funds, but said there were too few to meet the needs of small businesses. They felt the lower end of the market is underserved.
  • Montreal: Participants saw no shortage of capital, but said there may be a lack of diversification of investors. Government and institutional investors are the main players in Quebec, and they tend to focus mainly on minority investments. Few private sector investors exist who could bring operational experience and expertise to transitions. The buyout market is also less developed.

Read more about BDC Capital’s Growth & Transition Capital team and how it can support your business.


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