US small buyouts: Exploiting inefficiencies in the world’s most efficient economy

The US buyout space in particular is experiencing record high valuations at the large end of the market and record fund raising. However, there is a bifurcation of the market with a less efficient and less overcrowded “long-tail” of hundreds of thousands of smaller companies that offer attractive entry conditions for private equity investors.

After having grown to a larger size – often helped by the active intervention of the respective buyout fund managers – many of these companies can benefit from the efficient sales processes and surplus of capital seen at the larger end of the market. A caveat is that finding and managing investments in the “long-tail” of the US company universe is not an easy task.

A common worry

“Are the best days of US buyouts behind us? Has the market become too overcrowded with capital relative to the opportunity set at a peak time in economic activity?” These are just some of the thoughts keeping limited partners awake at night. Schroder Adveq believes that investors should sleep better; there are still highly attractive opportunities for those willing to do the hard work to find them.

US small buyout investments1 in particular present a compelling opportunity for investors to generate outsized returns and can serve as an alpha-generating complement to a mainstream large buyout portfolio. Highly specialised small buyout managers are able to utilise all of the levers of private equity value creation by capitalising on the inefficiencies inherent in buying and transforming small US companies.

Ultimately they can then sell these businesses into a well-capitalised, highly efficient buyer universe. Successfully investing in the small buyout space requires skill and the appropriate resources due to its scale and scope, so investors should be thoughtful in how they approach the market and construct their portfolios.

The world’s most efficient economy

Imagine a perfect setting for buyout investing: robust access to investment capital, business-friendly regulations and strong investor protections, combined with a highly liquid market for buying and selling a business. The US comes closer to this utopia than any other region with leading positions in global GDP, M&A activity, and capital market volume paired with a top 5% “Ease of Doing Business” ranking according to the World Bank.

The attractiveness of the US economy has also made it one of the most efficient markets globally for private equity and has allowed the asset class to generate strong returns for decades. As the market has become evermore competitive, investors can seek areas of greater inefficiency in order to continue achieving their high-return investment goals. One such area is the US middle market, often referred to as the “engine of the US economy.” This segment represents 50% of US GDP, employs half of the working population and offers a host of exploitable inefficiencies for investors to capitalise on.

1 Small buyout includes funds USD 2 billion and companies with revenues >USD 500 million.