As the private equity market has grown over the past few decades, large funds have attracted an increasingly large share of overall limited partner (LP) capital. Investors have gravitated towards large private equity funds under the assumption that they offer better returns and resilience due to scale and stability.
Our analysis shows that small and mid-sized private equity funds have, in fact, outperformed their large counterparts with more robust and persistent returns through time. Moreover, with the small- and mid-segment contributing the vast majority of opportunities in private equity, we believe investors should not overlook this valuable portion of the market.
Small- and mid-sized funds - favourable fund raising dynamics
We have analysed data from over 64,000 private equity funds and 400,000 deals in buyout, growth, and venture capital from 2000 to 2023 (for the purpose of performance analysis, we have excluded fund vintages beyond 2017, where performance is likely not stable. Single-deal funds and funds of funds excluded. Deals below $1 million are excluded). We classify the small and mid-sized segment as funds under $500 million and $2 billion respectively and deals under $50 million and $200 million respectively. The data presented hereafter encompasses all regions and strategies, unless otherwise stated.
Over the last decade, fund raising by large funds has far outpaced deal flow, resulting in higher competition and thus entry multiples for large deals. Large deal flow has grown at 1.6x, while fund raising from large funds has grown at 14.9x. Small and mid funds, by contrast, have experienced 2.7x growth in annual deal flow over the last decade, while annual fund raising has grown at just 2.4x.
Not only is the pace of fund raising growth much higher in large funds, fund raising levels are already far above the long-term trend, according to the Schroders Capital Fund Raising Indicator (FRI). The FRI is a Schroders Capital proprietary model that shows the areas of the private equity market that are above or below long-term fund raising levels. The long-term trend is based on fund raising levels adjusted for inflation and excludes business cycles. Excessive amounts of capital leads to more competition for deals, higher prices being paid and, ultimately, likely worse returns.
We currently observe that fund raising in European and North American large buyout funds is 100% above the long-term trend compared to only 40% above trend in small and mid buyout funds.
The "long tail" of private equity
Historically, the small and mid segment of the market has offered far more investment opportunities in both funds and deals.
According to Preqin data from 2010 to 2023, there have been 50x more small and mid funds in the market than large funds, and 17x more small and mid deal opportunities than large deals. In other words, the small and mid segment makes up the bulk of the "long tail" of private equity, accounting for 98% of all funds in market and 94% of all deals.
Entry multiples are more attractive in small- and mid-sized deals
Tracking EV/EBITDA multiples over the long-term shows a consistently wide discount between mid-market and large buyout deals (which today stands at around 5-6x).
This can in part be explained by the more favourable dry powder situation in the mid-market. But this is also due to higher perceived risk in small and mid-sized deals, where smaller companies may be less diversified and professionalised. Small and mid-sized deals are also often sourced through proprietary networks rather than through competitive auctions.
Please remember that the value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
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Issued by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registered Number 4191730 England.
For illustrative purposes only and does not constitute a recommendation to invest in the above-mentioned security / sector / country.
Schroder Unit Trusts Limited is an authorised corporate director, authorised unit trust manager and an ISA plan manager, and is authorised and regulated by the Financial Conduct Authority.
On 17 September 2018 our remaining dual priced funds converted to single pricing and a list of the funds affected can be found in our Changes to Funds. To view historic dual prices from the launch date to 14 September 2018 click on Historic prices.
