Understanding the Differences Between SMB M&A and Lower Middle Market Private Equity
Private equity and M&A come with their own set of abbreviations and terminologies that can be confusing. Terms like SMB, ETA (Entrepreneurship Through Acquisition), and LMM are often thrown around. In this blog post, we aim to demystify these terms and provide a clear understanding of the various types of transactions in private equity.
What is SMB M&A?
Small and Medium Business M&A typically involves smaller transactions that are often funded through SBA loans. These deals are usually characterized by EBITDAs ranging from $500,000 to $1.5 million. Sometimes, there is a "no man's land" between $1.5 million to $2 million where deals are too large for SBA funding but too small for LMM private equity.
What is LMM Private Equity?
Lower Middle Market private equity generally refers to transactions involving companies with an EBITDA of $2 million and above. Unlike SMB M&A, LMM private equity firms often have more substantial resources and seek to invest in companies that can scale significantly.
Key Differences
Size and Funding
SMB M&A: Typically funded through SBA loans, targeting smaller companies with EBITDAs between $500,000 and $1.5 million.
LMM Private Equity: Involves larger transactions, generally starting at an EBITDA of $2 million. Funding is often more diverse and substantial.
Level of Involvement
SMB M&A: The person leading the deal often steps into an operational role in the business, such as President or CEO.
LMM Private Equity: The focus is usually on finding someone to take over leadership roles rather than the deal makers stepping in themselves.
Philosophical Differences
Growth Perspective
SMB M&A: Growth is often seen as a long-term goal, focusing on organic growth over 10 to 20 years.
LMM Private Equity: The growth strategy is often short-term due to the finite lifespan of private equity funds. Growth is achieved both organically and through additional M&A activities.
Level of Business Sophistication
SMB M&A: Smaller businesses may not have formal processes and procedures in place because they aren't necessary at a smaller scale.
LMM Private Equity: Larger businesses require well-documented processes and procedures to manage complexity as the company scales.
Needs for Growth
SMB M&A: Focuses on fundamental business needs such as implementing robust accounting systems and tracking expenses.
LMM Private Equity: Focuses on strategic growth initiatives like entering new markets, developing new product lines, or investing in new facilities.
In the realm of private equity, particularly within the lower middle market, navigating new processes, procedures, or initiatives involves a distinct approach. Rather than executing strategies directly, our role often focuses on collaboration with the management team. We challenge assumptions, encourage diverse perspectives, and ultimately guide strategic direction. It's important to note that we aren't employees; we don't execute the strategy ourselves. This collaborative approach can sometimes be easier but requires different skill sets compared to direct implementation.
When comparing Small and Medium-sized Businesses (SMB) to lower middle market private equity, it's crucial to recognize that neither is inherently superior. Each has its potential for substantial returns, depending on the individual's approach and preferences. Some professionals thrive in scaling a single business from $5 million to $30 million over many years, enjoying deep involvement in its growth. Others prefer handling multiple deals, with shorter-term involvement in each, focusing on rapid turnover.
Personally, my career began in a company manufacturing widgets. Although I enjoyed this experience, I realized my true passion lay in deal-making. This shift led me to private equity, where I could engage with numerous deals rather than managing a single entity. This transition is embodied in Four Pillars, our private equity firm. While we don't claim to be the most successful, we are committed to continuous improvement and meaningful engagement with business owners.
A key takeaway in SMB private equity is the importance of relationships. The bond between the future operator or current owner and our team is paramount. We strive to develop strong relationships with sellers, as relationships are foundational to our success. By examining various market segments, we adopt the best practices and apply them to our work. In this aspect, SMB excels in building relationships with sellers, an approach we aim to emulate.
Understanding the differences between SMB M&A and LMM private equity is crucial for anyone looking to navigate the complex world of private equity and M&A. Each type has its unique characteristics, funding methods, and growth strategies, making them suitable for different types of businesses and investors.