The Year of the Seller: PE Fund managers scramble to build strong portfolios

Middle market companies – those with $25M to $1B in annual revenue – are the entrepreneurial fuel powering the American economy. But many of these companies are running on fumes. According to The National Center for the Middle Market, nearly seven in 10 middle market firms reported a year-over-year increase in revenue in Q1 2016, and about a third plan to expand into new markets over the next 12 months[1]. However, businesses in the lower mid-market (LMM) or firms with annual revenues between $25 million to $100 million, are struggling to secure additional lines of credit from lenders still reeling from the recession and, therefore, have limited or no access to traditional financing for growth plays like adding staff, or building out product portfolios. If you’re the owner or executive of one of these American success story works-in-progress, you may have already started looking into alternative funding sources like private equity (PE).

The good news for you as a seller is that globally, PE has had a stellar decade – from the biggest deal-making boom in 2006, to weathering the recession, to raising $500 billion worldwide in 2013 according to Bain & Company; with uninvested capital in 2015 at a record $1.3 trillion[2]. PE remains the best performing asset class in most LP portfolios, resulting in a land grab of wild-west proportions by fund managers looking to build strong portfolios. Not all mid-market companies are being courted by PE fund managers, however. Alternative markets research and analyst firm Pitchbook noted in a recent report that in Q1 2016, both the number, and value of investments by PE funds was down in the core middle market (CMM) or those companies with annual revenues between $100 million and $500 million, and the upper middle market (UMM) or those companies with annual revenues between $500 million and $1 billion. The surprise – at least to some PE market watchers – was the huge growth in LMM investing. It seems that many GPs are now figuring out what Lotus Innovations figured out when it launched its initial fund back in 2014; that smaller mid-market firms need capital and are lacking infrastructure for growth.

A Portfolio of Innovations: Looking Beyond the Start Up

Even if a company is the right size, many other organizational traits are considered by private investors before adding it to their portfolio. For Lotus Innovations, as well as many other PE firms, start-ups are usually off the table. Typically defined as being less than ten years old (often less than five), startups are in the under 100 percent annual revenue growth mode and are in the early stages of incubating a product or idea. This is usually the domain of venture capital funding.

For post start-up companies, private equity is an excellent alternative for working capital and resources. Lotus Innovations looks for specific qualities in a LMM post startup firm. Potential investments are tested against 9 criteria including factors like business model, scalability, target market, competitiveness, and market readiness. But there are innate qualities too that not only define a company’s culture, but help determine whether there is a good fit between the fund and the prospective client. First, post startups must still be nimble. They have grown from a core, dedicated team that has learned to wear multiple hats and approach their roles with a can-do attitude. Second, the post startup firm should be unique in their competitive space; either because of a solution, a service, or a way of delivering support. Finally, a post startup should have customers who can be converted to loyal advocates and future product testers. These partner-customers likely have been nurtured for years and have a long-standing relationship with company founders or C-Level executives.

Beyond size and startup phase, one of the most telling qualities of a poised for growth is its passion for new ideas. When a company has a high innovation IQ, many other qualities seem to fall into place.

How Lotus Defines Innovation

A common misconception in technology is that innovation is cold-pressed and organically grown only by startup hipsters. The reality is that there are a lot of unique approaches to problem solving in tenured companies. Lotus builds value for its investors both by being an innovator and by acquiring, then growing, and exiting a portfolio of innovative companies. Lotus sees opportunity in the growth potential of original ideas and approaches to problems facing the technology and telecommunications industry.

Innovation can be a better way to service a telecommunications company network and its customers. Innovation can be a way to help companies cut costs and improve productivity. It can be a way to help executives make intelligent business decisions through dashboards and reports. Most importantly, innovation isn’t a one-hit wonder; new ways of doing things and fresh approaches to problems are embedded into the culture of the organization.

When Lotus Innovations acquired portfolio company gen-E, it saw in the small consulting and services firm, innovative solutions to problems facing the mature telecom and enterprise networking industries. Launched in 1999 as a provider of network service assurance software and consulting for telecom and enterprise, gen-E experts saw the exploding growth of networking and knew that as more data and voice traffic hit the communication service provider and enterprise networks, performance and speed degradation would soon follow. The company expanded its offerings, deploying highly trained networking engineers and architects in the field with their top global telecommunications customers. It began offering training on the use of best-in-class network service assurance software, and offered pricing strategies and plans that were more in line with how telecommunications companies did business. But as it expanded, it needed capital to shed its startup persona.

Lotus Innovations acquired gen-E in early 2014. Lotus immediately embedded executives with deep knowledge of the telecommunications industry and applied the Lotus formula for growth including shared services. With the added infrastructure and back-office support, experienced technology industry guidance, and growth capital, gen-E has been able to significantly expand its product portfolio as well as its customer base. Its first software product, launched within a year of acquisition, was designed to help network operations and IT managers understand and predict network performance problems. In 2016, the company will launch the next generation of that software, which positions them in the advanced analytics market which is growing at a 33 percent CAGR between 2014 and 2019. Since the acquisition by Lotus, gen-E revenue has doubled year over year and the company is well positioned to hit its next growth target.

Four Ways Lotus Innovations Helps Tech Firms Scale Up

Innovation is critical to the success of a startup but often times, innovative financing can be the key to growth. Lotus Innovations was founded by a small team of telecom and IT technology entrepreneurs who had started firms, built companies and exited. They pooled their passion for technology, direct experience in financing and capital building, and the desire to help growing firms achieve a new level of success with capital and resources. The disruptive model they created – called the Lotus Methodology™ – is unique in the alternative investments industry. Lotus provides growth and leadership in four key areas that help lower mid-market, post startup firms scale up.

1. Technology Industry Experience

Lotus founders, board of directors, and strategic advisors bring over six decades of experience in telecommunications, high-tech, finance, sales, and operations to help grow their portfolio companies and build wealth for their investors. This experience is invaluable to companies looking to forge industry partnerships, court new customers, and make strategic decisions based on the needs they are trying to fill in their industry.

2. Shared Services

One of biggest distractions for companies in growth mode can be core business operations. As customers are added and employees come on board, complexities compound. Better networking and storage support is required. Finance and accounting requirements multiply. Attracting and keeping top talent is a concern. Building brand and a pipeline becomes critical. It’s enough distraction to derail even the best companies.

Lotus Innovations founders experienced this type of distraction as they scaled their own businesses. As a result, they decided to build operational and infrastructure support into the Lotus Innovations model. From acquisition through exit, a team of experts in the fields of Finance, HR, IT, Legal and Marketing works with our clients to build their business and their customer base. Lotus Shared Services helps clients move from distracted to dynamic.

3. Embedded Leadership

Lotus Innovations aligns an executive from the fund with the portfolio company. Because the leadership team at Lotus has depth of leadership across operations, sales, marketing, banking and finance, it can provide guidance to the portfolio management team on matters such as channel strategy, third-party partnering, revenue growth, procurement, and leadership development.

4. Transformation

The Lotus Innovations basic strategy is to provide funding and resources to help companies realize their full potential by assisting them bridge from an under-valued or under-performing organization to a growing, thriving business. The infrastructure support provided through shared services and embedded leadership together with operational guidance and support ultimately is aimed at helping the business get to the next level of growth.

[1] 1Q 2016 Middle Market Indicator, The National Center for The Middle Market, 2016
[2] Global Private Equity Report, 2016, Bain & Company, 2016

About Lotus Innovations

The Lotus Innovations Fund™, located in Southern California, is a private equity fund that builds wealth for its investors by acquiring, transforming, and exiting high-potential, small to mid-size technology companies that serve large enterprise customers in enterprise IT and telecom. The Lotus Methodology™ provides shared services support including Finance, HR, IT, Legal and Marketing; instant business infrastructure that takes a growing business from distracted to dynamic. The Fund’s founders, board of directors, and strategic advisors bring over six decades of experience in high-tech, finance, sales, and operations to help grow Portfolio Companies and build wealth for investors. For more information, please contact us.