Mid-market specialist The Riverside Company has closed its second micro-cap fund on $137 million, exceeding its $100 million target. Riverside Micro-Cap Fund II is the firm’s first Small Business Investment Company fund, and can add up to $150 million of low-interest rate debt from the US government’s Small Business Administration, bringing the fund’s total to $287 million.
The fund will invest in control positions in companies with under $5 million in earnings before interest, tax, depreciation and amortisation. It will employ the same strategy as its predecessor that collected $250 million in 2006, with one slight difference, Riverside co-chief executive officer Stewart Kohl told Private Equity International.
“Some of the $287 million is available not just for the equity component of the transaction but also for debt, whereas the $250 million in the first fund could also be used both ways but was overwhelmingly used for equity,” he said.
Limited partners in the fund include the State of Michigan Retirement System, which also committed to Riverside’s first micro-cap fund. Riverside employees, which regularly commit around 5 percent of each fund, committed 10 percent to Fund II.
Despite the “patient and cheap” capital from the Small Business Administration, not all investors embrace the US government-provided debt, Kohl said.
“There is a cohort of investors who have a perception of SBA funds based on maybe other experiences – that they’ve not always had the best managers, and that the structure of an SBA fund does give the SBA a preferential position,” he said.
While certain LPs appreciate the “specialness of small companies”, according to Kohl, others perceive businesses in the lower end of the mid-market to be risky investments due to their size.
“You typically don’t have the same multi-year or multi-decade track record to fall back on, you don’t have necessarily the same depth of management you would have, the same systems you would have, [and] you might not have the same claims to market share leadership,” Kohl said.
SBA funds, on the other hand, may become increasingly attractive to private equity firms over time, according to Kohl.
“I think the SBA is eager to increase the number and quality of private equity firms it works with and as folks have a good experience – assuming we do – naturally more will want to do it, because it is cheap and patient capital,” he said. “Our experience so far has been good.”
One disadvantage to SBA funds come in the form of restrictions on the amount of capital SBA funds can contribute to private equity vehicles.
“There are some regulatory limits right now as to how much the SBA can put in any one fund and with any one sponsor,” Kohl said. “We hope those amounts will be reconsidered and grow over time.”