I love the LMM
Dealing with managers you've never even heard of before, companies priced at 3-7x EBITDA, getting that 3-4x multiple expansion at exit. Just so juicy, baby.
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Those are positives for sure. Negatives are sub par management teams, protracted negotiations and smaller equity cheques to work.
Less sophisticated/experienced operators/deal participants from the sell-side make it that much worse as well. It seems like the smaller the market, the bigger the egos
.
Yes, multiple expansion is easy in that segment. In exchange, you sign up for torture in terms of quality of information, management, and internal operating processes for assets you do close on.
And if you try to ameliorate that by bringing in professional services resources that normally serve the upper end of the market, you're showing up with a Ferrari at a tractor pull - overpaying dramatically for something that just doesn't fit.
So you can suck it up and deal with the shitshow, and your reward is a great equity multiple ... on a tiny check.
There's no free lunch.
Is there a reason to care for the check size if the PE firm is smaller though? I work at a LMM boutique where we do really small checks compared to people here but the partners still make out decently well just cause carry is going out to a pretty small team. This is at a fundless sponsor which is quite active btw.
I swear in this industry people judge you so harshly if you work on small deals or dont have a fund lol. LMM just feels like a different animal.
I 100% get why people judge you for being an independent/fundless sponsor.
Usually means you couldn't pass DD with institutional capital/lack a track record.
This is coming from an independent sponsor btw, so no negative judgement, but I'm not going to pretend we have as much of a track record as a fund with $250mm of committed capital.
This mentally has nothing to do with PE. Culturally speaking, everyone gravitates to the saying "bigger is better".
I think if you do roll up your sleeves you can find a lot of value in the LMM. I back independent sponsors all the time, lots of them have consistent track records of 5-6x+ net and they're actually the ones operating businesses and not offloading it to some 65 year old operating partner or group of Bain consultants.
None beyond the fact that people generally want the greatest return on the least effort. It's natural to want to write the largest check you can for the fixed time investment of the deal process. Take small business lending: it's the same effort to underwrite a $100k term loan to a garage band trucking outfit as it is for a $10m loan to the local leader, which is why it's so hard to find reliable credit partners for microdeals. Anyone who can do it wants to do it bigger.
Having rolled around in the muck of this segment, my experience is that people immediately presume a fundless sponsor is someone who couldn't raise a fund. Which is fair, because that seems to be true about 9 times out of 10.
There is definitely a better proportion of opportunities for outsized returns the lower into the market you go. The problem when pairing the segment with the fundless sponsor model is that you can easily spend a couple years trawling for those gems only to come up with nothing but busted nets and a sore back for your labor. And have it be for factors entirely beyond your control: equity partners who jerk you around and disappear when it's time to close, a lender that buries you in committee long enough for a seller you had to coax and coach into being ready to sell to decide that your idea was great enough that they shouldn't bother waiting for you, finding some cancer during deeper diligence that makes you pull away after getting pretty far down the path ...
Say you beat all those factors and more and wind up an owner. Now the fun really begins. You don't have enough financial breathing room in the company to hire really capable management. So you're really in the mix yourself now, spreading yourself thin across each of the C-suite functions as a fractional resource.
What you'll discover the longer you're in this industry is how little muscle and how weak a stomach most people in finance have for actual operating responsibility. It's one thing to sit in a boardroom and talk about the upcoming quarter's objectives and an entirely different thing to bloody your knuckles against the wall banging things around to make them happen.
So the judgment you feel is two-fold: a pejorative assumption that the firm isn't of a caliber that deserves a fund, and a distaste for the type of work common to that market.
To the first, shrug it off, fuck 'em. To the second, to each his own, your mileage may vary, and all the other sayings ...
You gotta remember the law of large numbers. This site has people who follow 'the path'. The firms like yours maybe don't have a website, or if they do it's basically a landing page. The deals never get picked up by the press. The only people aware are the parties involved and the services vendors attached. It's not a known phenomenon, and frankly, some people get belligerent at the idea it's possible to earn more doing something a different way than the center lane on the path.
One thing I'd say in closing is that it's interesting to see how people who succeed in this model progress over time.
Some go on and raise funds. With a track record of a couple wins plus their personal dollars from those outcomes, they now have the ingredients of a GP commit and attributable deal performance. They have the know-how and relationships, so moving to the fund model is great because they can hire a team and enjoy better resources.
Some hate the idea of all the administration a fund brings and stay in the independent sponsor lane. This always works best with equity partners who know and trust you from prior deals and are happy to follow you into new ones. Here I've seen some guys be pretty explicit about going up-market, following the logic of getting more juice for the same squeeze. It's also possible to get better sponsor economics. As the anonymous guy "Partner in PE - Other" noted, there can be real fat returns. The first person who opened my eyes to this was on a 30-over-10: 30% carry, 10% hurdle, full catch-up. He was nine years in and closing his fourth deal when we talked. He had three massive family offices on a rinse-and-repeat thing. People pay for performance.
Some lay back and start allocating to other guys doing the same thing, maybe for preferential terms because they can help out as advisors.
The amount of work to check size is not linear. Writing a $300m check vs a $10m check does not take 30x the amount of work or workforce. Very rarely does it take any additional amount, but let's say it takes 3x the amount. Let's say each investment doubles and carry is 20%. Investment 1 generates $60m of carry for 6 people ($10m each) while Investment 2 generates $2m for 2 people ($1m each). Even if Invest 2 4x, that's $6m of carry for 2 people ($3m each)
Ignore my job title - I now work at the MM fund of a MF that gets mentioned occasionally on here. I looked at one for 3x EBITDA very briefly. Was a titanium mine in Ukraine in August 2021. Apart from that I don’t see many.
Some random stats of ours for you if helpful:
We have bought 12 platforms at Hidden Harbor. 10/12 were 6-7x range. 2/10 in the 4-5x range.
We have had 2 full realizations to date. One at 13x (bought at 6.5x) and the other at 11x (bought at just under 7x). [Several other partial realizations]
How much of that is timing though?
How much of the multiple expansion was due to just wrapping up a handful for 6-7x companies and bundling them into a sufficiently large enough package to convey diversity of risk that can command a higher multiple?
Oh look at you, you’re so quirky and special!
Such a silly goose!
How common are deals priced at 3-4x "true" EBITDA? I'd say 20% of the deals bankers send me are priced in that region, the rest are more around 6-7x.
I looked at two companies priced at 3x recently and we passed. Both actually had good financial fundamentals but their business sectors weren't great.
First was in the footwear business - they made insoles and priced them like 200x their cost basis. EBITDA margins were 25%+ without fail each year and it was growing around 5% organically each year. We thought it would be pretty easy for another group to arbitrage them based on that price point. Sponsor that ended up doing it was an independent sponsor that is highly regarded - consistently done 7x+ MOIC deals.
I only do consumer but sub 6x or so definitely implies the business has been growing really really slowly, has some major issue, or under $3m EBITDA in most cases.
EBITDA was around $7mm. Organic growth was certainly slow historically but was up 40% last year, bit of an anomaly. At any rate, I'm avoiding most businesses that had huge revenue spikes just due to covid - often it can't be maintained.
I saw another business priced around 3.5x today. Basically they just do implementations of custom closets, custom garages, custom gaming rooms/mancaves. Pretty shitty business.
Another one around 18% EBITDA margin was a waste disposal company. Was actually not bad but too much competition and only operated in one state. I'd rather pay like 6-7x and sell for 10-12x then pay 3x for crap and sell for 3x 5 years later.
Me too! Spent several years at a larger fund, but feels good being back home in the LMM churning out 4-7x bids!
Although, as others have highlighted, not an 'easy' strategy and takes a lot of work to professionalize these businesses, and the model doesn't scale as well (we have ~30 people with only ~$700M of AUM, so not swimming in fee income atm....)
Do you think your time at a larger fund prepared you better for the LMM?
Interned at a LMM for a full year, was an independent sponsor with a little more jazz(one fund which wasn’t ever closed). Classic roll up strategy: Buy a semi stable platform and bolt on companies like a mantic 5yo with a new Lego Bionicle. Most common sentence in IC was “I like it, but there isn’t enough hair on it for us”. It truly is the Wild West down there.
Another thing is that proprietary dealflow doesn't really exist at large cap. Any $1bn+ company going through a sale process is going to hire BB bankers and fully exhaust all strategic alternatives when going through the process because of the stakes involved. This + lack of room for operational efficiencies makes multiple expansion really, really hard at a certain size.
My fund just purchased a 30% EBITDA margin platform for ~4x EBITDA when other comps were trading for 12x - 15x because we were able to source the deal through a connection and convince management that we are the right capital partner to help drive the next stage of growth and allow them to unlock much greater wealth creation than the first payout (management rolled over 35% of equity). They didn't even hire a banker! All of these things are possible, but much less likely once you hit a certain business size threshold.
so is the owner a dumbass for leaving that much value on the table? this smells fairy tale
Not sure as I wasn't on that deal team so less familiar with the exact details but there is some relatively significant tail risk with this investment as their customers are chunky (this is a pharma services company and a couple of large cap pharmas are >50% of their revenue) and they were audited by the FDA recently (passed a few months ago with no issues). Their backlog got significantly weakened due to noise during the audit so near-term growth is stunted.
Still worth more than the 4x we paid but even if they went out to auction they likely wouldn't be able to get 15x - prob closer to 9-11x or so. We also have an additional turn in an earnout which brings total consideration to 5x EBITDA.
We bought in because we are confident we can turn this thing around (they aren't distressed by any means but not the healthiest company in the space given aforementioned issues) due to previous experience by our seniors + a really good executive we found during the process we can plug in. We've also structured the management team's rollover to be subordinate to our equity to soften the downside.
Whether the owners are dumbasses or not I guess depends - sure they would have gotten an incremental 4-6x in a process (~$25mm) but they would still have had to rollover a substantial amount and stake a big part of that value on future performance. I think we did a great job of convincing them we are uniquely positioned to facilitate their growth and make sure an outsized second bite of the apple makes up for the lower initial valuation.
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