With the global economic landscape further veering into the direction of higher interest and inflation rates, accompanied by a general monetary tightness, searchers today are often faced with one specific question from investors when it is time to acquire a company: What is your exit strategy for this company? And are small-cap companies in Europe, with an EBITDA-range of EUR 1-10 million and a valuation of EUR 70 million or less actually exitable?
The short answer from us at Moonbase Capital is “Definitely yes.”
But don't just take our word for it.
We spoke to leading investors Sacha Talmon of Weinberg Capital Partners and Basile Phelipeau of Ekkio Capital to get their thoughts on the exit prospects of small-cap businesses in Europe in the current climate. Below are the 3 main takeaways:
#1 Small-cap transactions > large-cap transactions
Bain said it best: “Global buyout value dropped by more than a third in 2022 as banks veered away from large transactions over the summer,” according to the consulting firm’s Global Private Equity Report 2023.
So what does this mean? Large transactions have become very costly, with interest rates skyrocketing across the world, thus increasing the cost of acquisition debt. “Banks are extremely cautious right now when it comes to large transactions, but they’re flexible and open for business for small transactions,” Executive Director at Weinberg Capital Partners Sacha Talmon says. “If you look at the amount of transactions made from the end of last year until now, the M&A activity in the smaller-cap market is still quite resilient, and although activity has slightly dropped, it is nothing comparable to the drop that happened in the large-cap market,” he adds.
If you look specifically at Europe, syndicated loans for large leveraged buyouts more than halved from USD 410 billion in 2021 to a mere USD 203 billion in 2022, according to Bain’s report. A similar trend can also be seen in the US.
Banks pulling the plug on loans for large buyouts isn’t the only thing that makes a case for buying small-cap companies. “There is much more activity on that end of the spectrum in France and in the European countries than for multi-billion transactions,” Sacha explains. The valuations of those deals also gained ground, with the financing squeeze allowing smaller deals to gain share while deal sizes remained high, Bain’s report explains.
#2 The buyers are there
There needs to be a clear distinction between the US and European markets. Firstly, Europe is much more diverse when it comes to investment and fund setups, because each country has its own unique way of doing business. That is why the US’ definition of a “small-cap company” lies way higher than what Europeans consider small-cap at a maximum valuation of EUR 100 million.
Secondly, PE funds are very popular and widespread across most European countries, with a stronghold in France. “Starting at EUR 5 million EBITDA, you have a market for majority funds with a proper exit,” Investment Director at Ekkio Capital Basile Phelipeau says. “At EUR 10 million EBITDA, you have a proper chance to get scooped up by PE funds.”
And with the increase in small deals, this has been solidly happening, especially in France. Exhibit A: In 2022, between 55-60% of investments in France were made with tickets ranging from EUR 5 million to EUR 100 million, according to France Invest’s Activité Des Acteurs Français Du Capital-Investissement report for March 2023.
#3 An added plus: A focus on ESG
Having an ESG-angle within the acquired small-cap company could be an advantage in the future. As of recently, the attention of investors is sliding towards profitable companies that fulfill ESG metrics and guidelines. There is a growing belief amongst surveyed experts that a focus on ESG issues benefits a company's financial performance, with 71 percent agreeing that the ROI of ESG exceeds the costs, according to PricewaterhouseCoopers’ Private Equity Trends in Europe report.
Sacha Talmon seconds that, not only because he sits at the head of an impact fund, but also because he has seen interest from a wide array of investors. “Profitable, ESG-focused companies attract significant interest from different types of funds, such as generalist funds, impact funds, family offices, and sector-centric funds, such as the ones focused on the energy transition,” he states, emphasizing that the inclination is evident.
Let’s fast forward into the future a bit
Today, many search funds are looking to acquire small-cap companies. They will be ready to exit them in 5-10 years time. By that time, the monetary tightening of global markets will have easened up a bit, leading to expectations that the M&A market will pick up again to pre-COVID-19 levels, Basile says. Search funds are a game of the future - and we, as Moonbase Capital, will be there to witness it and keep pushing for profitable exits.