Consider ultra-LMM

Consider ultra-LMM, firms that invest in companies around $2-5M in EBITDA. You pick up these unassuming companies at 4-6x, roll-em up to get to a company of $5M-$10M of EBITDA which opens you to a much broader range of buyers in the LMM-MM space who are more than happy to pay 8-10x


At that point you have achieved the ultimate buyout goal "MULTIPLE ARBITRAGE"


Sure you may not be in the AUM Hall of Fame, but you are now in the IRR HOF. 


Also consider fundless sponsor structures. You get paid your carry on a deal by deal basis, no more waiting for carry to vest or risk of clawbacks.


You either hit a grand slam or strike out.


You and your buddy with a couple mill in the bank to invest, team up to look for golden nuggets and work your M&A magic to easily return 5x+ MOIC


Do a deal or two a year and you are set to make $Ms/year once you get the ball rolling

 

Being an independent sponsor is not cool. I have never met anyone that said "I'd like to scrounge my way through life having to act legit to intermediaries and sellers and then try and peddle that same deal to backers to get capital." Having a stable job at a reasonably sized firm with committed capital is cool, regardless if it is LMM, MM, or larger.

 

It's definitely not an issue funding these small deals. Once you have a track record, you essentially work with the same backers. You give them great results and they will call you up asking for updates on the next deal. These FoF and endowments are also eager to deploy capital. If one passes on the deal then there's many more out there. You are doing them a favor by offering an entirely different asset class. They are happy to pay the management fee and carry for outsized returns and if the deal goes bad it's a drop in the bucket for them. Nothing peddled and no running around required. They also act essentially like an IC. 

 

It's definitely not an issue funding these small deals. Once you have a track record, you essentially work with the same backers. You give them great results and they will call you up asking for updates on the next deal. These FoF and endowments are also eager to deploy capital. If one passes on the deal then there's many more out there. You are doing them a favor by offering an entirely different asset class. They are happy to pay the management fee and carry for outsized returns and if the deal goes bad it's a drop in the bucket for them. Nothing peddled and no running around required. They also act essentially like an IC. 

We just write the $ ourselves and then sell a chunk of the equity later, this way we can move way faster. 

Sometimes we use our LP roster on entry too. Like you said, eventually you're on good enough terms with your LPs such that getting a check quickly for w/e you want isn't a big deal. 

 

Definitely not true. One of my wealthy friends help invests family capital via independent sponsor - I don't think they raised any capital (father had a very successful career in investing/creating a company early on -- focuses on ultra LMM investments now, 7 figure buyouts etc). Sky is the limit but definitely not a 9-5 lifestyle.

 
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My firm has the exact same strategy. Located in a LCOL area and make just under 200k while only working 40-50hrs/week (60-70 during live). Super lean team (2 Co-founders, 1 VP and 1 Aso)

I had offers to join multiple JAMMBOs (just another middle market buyout) with comp around 250-275k but after speaking with my firm's founder, he sold me on this value creation strategy that he built his career on. He does pretty well for himself, net worth ~$50MM so not MF partner money but definitely up there.

I am allowed to co-invest my bonus into our deals. 8 months after closing on my first deal at ~6x, we have generated a very healthy cash balance and our EBITDA has increased 50%, so potential returns are looking good. Once we close on a bolt-on acquisition or 2, we can easily flip the company for 10x.

We definitely underwrite the deals very conservatively and for the most part, we are never bidding against anyone as these processes are not competitive.

Sure it may not be as prestigious as MFs or even your typical MM PE firms, but I see it as more of a long-term career path rather than a 2 and out program. I do consider myself very lucky to have ended up at my current firm with a great WLB and culture. 

 

We have relationships with 100s of M&A advisors who send us stuff and firms on retainer to cold-call companies that would make sense as add-ons for our platforms. We also have people that will send us stuff and they get a finders fee of ~200k if we close.

We already have a pretty good infrastructure in place, but I will still cold-call advisors and follow up on deals just to build my own relationships.

 

You've certainly drank the koolaid. If he is worth 50mm and you're only make 200k then something is off.

 
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This is a well used strategy by a lot of UK based pe funds operating in this space. Have a constant stream of interns getting paid 25k to scroll google/online databases looking for suitable businesses. Very smart strategy when you consider that you’re often paying 2/3 turns less on the ebitda multiple on an off-market vs process ran sale.

More generally, I’ve seen quite a few PE funds do very well in this space. In the UK there’s a newish fund (around 5 years old) which invests in 2-5m ebitda businesses. They just exited their first 3 investments and have averaged a 3.6x multiple. Strategy was a ‘buy and build’, essentially an intelligently integrated roll up of multiple similar sized businesses over a few years.

I’ve also heard the same fund offered their first hire - a VP - around 5/10% carry. Considering the first fund was 150m and currently on track to return 3.6times, very nice bonus.

 
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Really common route; nothing new here. Strategy works.

Waterland in Europe has institutionalized this and is a top 10 global PE in return metrics; latest fund €2.5bn so evidencing ability to also scale the approach.

Many local Benelux, UK, etc. LMM houses who do this and sit on fund/track record returns of 3.5-5.0x MoIC and occasionally with carry pools beyond 2/20 due to the excess returns. The real magic in IRR terms happens when you finance via DDLT + vendor loans - meaning no cash out. If you can find a nice Unitranche facility with a rising tide (i.e. max leverage covenant that tracks EBITDA) and you can buy smaller assets at 4-5x with leverage at 5x you can even not only buy without additional equity but "delever" with synergized deal EBITDAs. 1+1 = 5. Employ standard deal teams for the DD with a subscription and fixed Engagement Letters (FDD, legal) to minimise admin work and have an integration + deal FTE (or via CFO) within the company - this massively pays off vs their salaries.

As an investor having looked both at the MM deals and covering an asset which had a roll-up strategy (>15 add-ons done in 1.5 years) however, I can confirm it generates sexy returns but its not an interesting job. Turning the handle on 1 add-on per month isn't super rewarding - but it definitely works.

LBO-modeling companies on a Corona-adjusted normalized proforma run-rate EBITDA basis since 2020.
 

The LMM strategy generally works and for those looking to make decent money and have a good lifestyle, it's a pretty good gig. With that said, like everything else in the world, it does have its drawbacks. 

The first is that this strategy doesn't scale. If you love playing in the LMM forever and never want to raise a bigger fund or grow the team that significantly then yes, you can run a lean team of ~5, only hire when people quit, and have a nice existence rolling up small companies forever. That caps the growth of the fund and growth of potential earnings, not only for yourself, but for others at the firm as well. Partners make out ok, but anyone below likely wants bigger funds and more economics. So imagine this, you're hired as a Senior Associate with a couple folks below you and a few above. You have a $200M fund that you deploy into 6-10 deals. Next fund comes around and you're up for promotion, problem is that if you only raise $200M again, there's not enough salary and carry for everyone to move up and continue to get paid. If you go up to $500M then you're into a different weight class in terms of deals...If the fund is small enough a partner could decide to give up their economics, but that only works up to a point.

Second, small PE deals require almost as much effort as bigger ones, and there's way more risk involved. Small deals are inherently messier. The books aren't' as clean, the companies aren't as well run, you run a higher risk of running into some binary risk type of situation. At the same time, given the resources of the fund, your'e likely not paying Bain to do a $1M diligence on the project, so while you're doing some basic diligence, the risk of a $4M EBITDA business going under is much higher than a $10-20M business. That's not to say it's way riskier, but there is simply a higher risk for smaller companies. This makes moving up market more appealing.

Lastly, at the end of the day, the best way to make money in PE is to get to a point where you've got a few B in AUM and are just trying to return 2x. I'm not going to go into all the math, but at a high level if you're comparing returning a 4x on $200M vs a 2x on $1B, you're better off economically by being an average performer with a bigger fund. So now you've got a situation where you can make more money and take fewer risks given the scale of the businesses you're looking at with an average sized MM fund.

So yes, I completely agree that there are benefits to being in the LMM, but it's getting more crowded and most fund managers who successfully raise and deploy a ~$100-300 LMM fund, who have the opportunity to raise a second, larger fund, very rarely opt to keep the fund size small. It's a mix of economics, risk, and honestly, ego. Most of the partners I've come across enjoy the pursuit of deals and measuring themselves against others, versus making a few million dollars and just deciding to mail it in.

 

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