As the private equity industry rounds out a year that makes most want to time travel back to 2021, sponsors are changing directions within the lower and middle markets.

After seeing a downturn due to macroeconomic factors, interest rates, and the high likelihood of a recession looming, Firms are tweaking their strategies to take full advantage of what could be a complete market cycle shift.

As valuations are cooling off from last year’s highs, smaller deals in fragmented markets are getting more attention, specifically through roll-ups and add-on acquisitions.

Now that the valuation craze has (temporarily?) calmed, sellers must come to terms that yesterday’s price isn’t going to be fought for today, and Firms are happy they are able to scoop these smaller companies up at more accretive multiples. Using the classic buy-and-build Private Equity playbook, the synergies that can be realized will be much more focused on these add-on transactions to take advantage of the more attractive multiples. This will also be seen through the Upper Middle-Market and Mega Funds looking for add-ons, which more exit opportunities will be originated.

In the same light of PE firms looking at smaller companies, the shift to growth equity investments will also be drastically increased, taking away (or providing) opportunity to their venture capital counterparts. For most of the venture community, investors are gripping onto their potential unicorns tightly, doubling down on their positions and leaving more would-be fund investments up for grabs for other investors with that dry powder ready to deploy.

With the changing tides economically and shifting strategies, the portfolio company level has seen management style changes, with an increased focus on free cash flow management to gain an advantage ahead of the recessionary writing on the wall. Never is it more important to have specialized Operating Executives that can step in, execute on a playbook they’ve done a thousand times, and prepare the portfolio company for macroeconomic factors that could affect the business itself, but also build the company in a way that an acquisition is not only streamlined, but maximizing the value and return potential of it.

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