LPs may flood US mid-market with capital

The lower to mid-market in the US is poised to get flooded with capital as limited partners look for exposure in the space, and the expansion of money will inevitably lead to losses for some investors. 

LPs, according to surveys done over the past year, are keen on getting exposure to the mid-market, according to Brian Gallagher, managing partner with fund of funds Twin Bridge Capital Partners. Gallagher was speaking on a panel at a conference in New York on Wednesday. 

LPs that in the past only had appetite for mega-funds and “got burned” in the downturn “are starting to look harder at the mid-market”, said Barry Gonder, general partner with Grove Street Advisors. 

The problem is a large amount of capital flooding one area of the private equity space can lead to “distortions”, Gallagher said. 

“Everyone thinks the mid-market is this magical territory and the greatest returns are there and I can just pluck a good deal,” Gallagher said. “Some people will not make allocations to the right funds … mistakes will be made.” 

The bigger LPs interested in the mid-market will probably not look into the lower end of the mid-market, Gonder said. “There's few opportunities to be in the lower mid-market for someone who needs to write a $100 million check,” he said.

It’s a dicey thing to go down-market because at some level that’s a deviation of your strategy, and we believe your strategy should be the same fund in and fund out. You shouldn’t be trolling in our space. Brian Gallagher

Panelists discussed the opportunities in the mid-market, which is “significant” because of less competition, lower prices and less leverage, according to Gonder. Also, smaller companies in the mid-market give managers the opportunity to make operational improvements, he said. 

The financial downturn has been particularly hard on the mega-fund space, with its high levels of leverage. The mid-market has had a relatively smoother ride through the recession. But risks remain in the space, especially when it comes to manager selection. 

“Selection is harder in the mid-market. There are a lot more funds … unless you have a professional who can go in and do the due diligence … it’s almost easier to pick one of the top eight mega funds,” said Greg Oberholtzer, managing director with WP Global Partners.

Mid-market firms are not seeing increased competition from larger firms trying to get into the smaller space, panelists said. 

“It’s a dicey thing to go down-market because at some level that’s a deviation of your strategy, and we believe your strategy should be the same fund in and fund out. You shouldn’t be trolling in our space,” Gallagher said. 

The recession has helped investors identify true, quality managers and firms that may have a hard time raising future fund.

“Every recession leaves its mark on the world. In this case, this recession established the role of the operating talent within private equity firms as a permanent one,” said Bela Szigethy, co-chief executive officer of The Riverside Company.