How Private Equity Micro Cap Funds Changed M&A Activity

By Generational Equity

10/04/2011

A few years ago the Riverside Company became a leader in the micro-middle market with its creation of the Riverside Company Micro Cap Fund (RMCF). At the time, the fund was founded with the stated goal of focusing on investing in companies with EBITDA below $5 million (EBITDA = earnings before interest, taxes, depreciation and amortization).

The year was 2005 and, back then, equity firms acquiring billion-dollar deals with significant leverage were getting all the publicity. Of course, the financial crash of 2008 changed all of that and firms like Riverside, who had created a fund to focus on the much more stable, less risky micro-middle market ended up looking like geniuses.

Over the years, RMCF has been very active, acquiring 19 companies per their website. One of these portfolio companies is Polar Windows, a company that Generational Equity represented in December 2007.

RMCF has been so successful that it was recently announced that Riverside had completed fundraising for a RMCF II, a second micro cap fund with the same focus: middle-market companies with less than $5 million in EBITDA.

In fact, RMCF I was so successful in generating solid returns for its investors that Riverside was able to raise 37% MORE capital than its original goal of $100 million for RMCF II. In the challenging current fundraising environment, this is quite impressive.

In addition, RMCF II is also tapping into funds available under its designation as a Small Business Investment Company (SBIC). As an SBIC fund, RMCF II will have access to low-interest rate debt from the Small Business Administration (SBA). Through this SBA program, RMCF II can add up to $150 million in capital, providing RMCF II with a total of $287 million to invest in control positions in smaller, micro-cap companies.

“We love these fast-growing, innovative smaller companies. We want to take these gems into our jewelry shop and design and shine them to a previously unimaginable brilliance,” Riverside Co-CEO Béla Szigethy said. “But finding financing for them is a real challenge. So the SBIC, with its inexpensive and patient capital, is a made-in-heaven solution for us. The SBIC program has been around since 1958 and has proven results. It’s been a pleasure to work with the SBA through the licensure process. We look forward to using this war chest to buy and build a dozen or more of the best small companies in America.”

Not only was Riverside successful in partnering with the SBA in this new fund, they also drew a covey of returning investors from RMCF I. This is a testament to their ability to generate an ample return for their investors over the years. In fact, 62% of its commitments in this new fund are from existing investors from RMCF I. In addition, employees of Riverside regularly commit at least 5% of each fund, representing a significant portion of their net worth. In the case of RMCF II, that commitment was 10%.

The Micro Cap’s Relevance To Your Business

You may ask, why are you highlighting this fund? We do so not only because of our ongoing relationship with them but to emphasize to middle-market business owners that you really do have options when it comes to finding buyers for your companies.

Riverside is a great story because RMCF I was created just prior to the great recession. However, despite this really big bump in the road of investing success, RMCF I soldiered on, acquiring 19 companies over the years and generating a substantial return for its investors. They survived and even thrived BECAUSE of their focus on the lower end of the middle market. They blazed the trail in the micro-cap investing world and now there are literally dozens of firms that have funds like this. Many of them are funds that were created after the financial crisis since financing for highly leveraged, mega deals dried up.

The challenge for you when you take your company to market will be getting in front of the right people at the right firm at the right time. This is not easy to do especially since you probably will only sell one company (your own) in your lifetime.

Positioning it properly so that your valuable intangible assets are clearly seen by buyers takes skill and experience. Not every investment firm or corporate buyer will see the same value in your intangible, “off balance sheet” assets. Many will focus solely on your historic earnings (again pointing out how critical it is to have your financials recast). However, what you want buyers to focus on is your future earning potential, much of which is driven by the uniqueness of your business model and operations. Having the help of an experienced M&A advisory firm is vital in order to get buyers focused on your unique features and their effect on your future earnings.

As I mentioned earlier, Generational Equity is quite familiar with Riverside since we represented a company they acquired several years ago. But this is just one relationship we have with an equity firm. Keep in mind that there are literally thousands of buyers like Riverside out there focusing on the lower end of the middle market. Our deal makers, given their years and years of experience, have connections and established relationships throughout the buying community.

If you would like to learn more about how you can effectively position your company to be of interest to buyers like Riverside, I would suggest that you should attend one of our workshops. Generational Equity is dedicated to educating business owners on how and when to sell their businesses for the most profit. People who attend our seminars tell us that the few hours they spend in the conference is the best investment of their time in years. We would be glad to see if you qualify to attend and learn more about this critical topic.

Carl Doerksen is the Director of Corporate Development at Generational Equity.

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