Investing in ‘Low-to-Mid’ Capital Growth
Growth capital is a form of private equity that involves investing in established, profitable businesses that are seeking a partner to provide capital and strategic guidance to maximize their growth. The number of opportunities in ‘low to mid’ growth capital is large. There are approximately 48,000 investable private companies that have between 20 to 499 employees based in Australia or New Zealand. In addition to a large opportunity set, there are also favourable market tailwinds in terms of business owners wanting to exit their businesses. The Institute of Public Accountants provided analysis in 2016 that of the two million Australian private businesses, over 70% of these businesses are owned by baby boomers and most baby boomers plan to exit their business in the next ten years.
(Source: “The Baby Boomer Business Exit Tsunami” – November 2016; http://www.smh.com.au/small-business/trends/can-the-boomers-sell-their-businesses-20150312-1428k0.html).
Number of private companies within Australia & New Zealand (Source: Orbis)
Valuation multiples in the Australian growth equity market are attractive with our average entry multiple for investments from 2013-2017 at 6.4x EBITDA, relative to the Australian LBO average of 8.2x EBITDA. And, on average, low-mid growth equity businesses are acquired at significant multiple discounts to larger businesses which creates an attractive entry and exit dynamic for investors. The scale of the market also enables there to be a high proportion of proprietary and exclusive deals; for our team, this was around 50% by number over the last 12 months.
Despite the attractive attributes of the low-mid growth equity market, there are less than 20 active growth capital funds operating in this market. This is in comparison to the 12 larger private equity funds that typically target companies with greater than 500 employees whilst having a market opportunity set of approximately 1,000 companies.
"Investing in smaller companies provides significant scope for operational improvement"
Investing in smaller companies provides significant scope for operational improvement, particularly through supporting and developing the management teams. Many private equity firms have built separate operational teams and deal teams so that the operational team can focus solely on the development of investee companies. However, we have always had a strong focus on operations and go into every deal with a clear strategy of how we are going to support management teams to build the business through to an exit process. Whether it is managed through the deal team or a separate team, a critical part of growth capital investment is to ensure that the team managing the investment is actively involved from beginning to end.
Investors need to be aware that you usually need to qualify as a ‘sophisticated investor’ in order to access growth capital investment opportunities from Blue Sky and other investment managers that offer these types of investments. To qualify as a sophisticated investor you, or entities you control, must have aggregated gross income of at least AU$250,000 in each of the previous two years or net assets of at least AU$2.5 million. If you do not qualify as a sophisticated investor you can still access private markets investment opportunities as a retail investor through listed investment companies, such as our Alternatives Fund (ASX: BAF) that gives investors access to a diversified range of private markets investments across private equity (including our ‘low to mid’ growth capital investments), private real estate and real assets.
Led by Nick Dignam, the Blue Sky Growth Capital team continues to build momentum. They have a strong sector bias and favour investments in sectors we call the ‘essentials’ – 7 out of the last 11 investments were in three of our target sectors of food, healthcare and education. But perhaps the most important and unique feature of our Growth Capital team is a genuine partnership approach to investing, including the willingness to take minority positions.
Vaughan Henry, Blue Sky Alternative Investments