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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   October 2009

Big Profits in Small Markets

Private-equity investors could be solutions for numerous niche borrowers

In many aspects of business and life, bigger is not always better. This is particularly evident in the world of private-equity investing.

The largest private-equity firms typically won't even look at an investment of $1 million or less. Small-market private-equity investors thrive on larger companies' oversight. They typically understand that often, the only thing many small-business owners need is a minor amount of money to land their first "big" contract. In fact, these smaller investors often find and fill niche opportunities in their local or regional markets.

Small-market private-equity investors invest in many ways. They continually conduct fundamental, bottom-up research to identify "in plain sight" niche markets in core, everyday business sectors. They search for gaps in the marketplace that have been overlooked. They search for unfilled demand and for waiting lines that extend beyond the foreseeable future. They scan market sectors for competitors that have grown too big to compete in certain markets. 

When they find a niche that needs filling, they often look for -- or even start -- a company that can fill the need.

Brokers helping their small-business clients seek funding for various needs would benefit from knowing some examples of niches where small-market private-equity investors can help.

Companies seeking expansion

One strategy that smaller private-equity firms employ is finding small companies (i.e., those with $500,000 to $5 million in sales) that have good management teams but that have reached the limit of their capital. These companies often have given all they have to a top-notch idea and need capital to take the idea to the next level.

These companies are everywhere. Anything you can think of that has a sizable profit margin is a candidate for private-equity investment.

For example, a small scrap-metal dealer recently wanted to expand into other similar markets in its city. It was well-located, with sales around $1 million per year and a profit margin around 40 percent. Its niche in the market was that it was located in a poor part of town where residents collected and cashed in scrap metal to buy groceries. A small private-equity investor saw this as an excellent growth opportunity that needed a little capital to expand.

Similarly, a gasket company near Detroit recently needed capital to expand. It had its market study, its sector and niche identified and all the supporting research to convince any equity investor that the expansion was necessary. What the company lacked, however, was the equity to get a banker interested. In the end, a small private-equity investor made the investment, the company doubled its sales, and the equity and loans were paid off within three years. This investment essentially was a perfect private-equity scenario.

Energy and food

Another marketplace in which private-equity investors are increasingly interested is that of energy-related businesses. For instance, the time of peak oil has come, the era of cheap energy supplies likely is coming to an end, and traditional and alternative energy will reap tremendous rewards for smart investors in the next 50 years.

Some of the more-appealing aspects of these factors for investors are solar-panel manufacturing, personal wind-generation and battery technology, to name just a few.

The organic and locally grown food marketplace also has gained expansive public support and the buying power to back it. This market also likely will grow many small companies with well-positioned managers in the next 20 years. For investors, the profit potential is huge.

Self-storage market

Looking at property types, the self-storage market often is viewed as recession-resistant. In fact, when the economy turns, self-storage typically gets more profitable.

There are many concepts related to this market that attract small private-equity investors. These include: recession-resistance, core business, hard-asset-based business, job creation, sustained growth, cash flow and easy exit strategy. These factors often compel small investors to do the research, create the business plan and locate the management teams for these properties.

Changing demographics

Demographics are rapidly changing in the United States, and many small-market private-equity investors are finding opportunities within these changes. An example of a high-profit, high-growth area is the Hispanic population, the country's fastest-growing ethnic group. There are many high-value investments and businesses that serve this population and that likely will make billions as the population grows. Many will require only a few-thousand dollars of investment. 

One example of this niche market is the taco-stand -- or taqueria -- business. In almost every sizable town in Texas, for example, there is a new taqueria. The markup in this business is extraordinary, which leaves room for error. A taco that costs 15 cents to make will easily sell for $1.50 -- now that is a profit.

If you find the right location and the right management team, these businesses can be excellent sources of revenue with tremendous expansion opportunities.

•  •  •

Small-market private-equity investors often will take the time to listen to and consider new proposals as long as the deals are not burdened with too much debt. Some require a maximum of 50-percent leverage -- and usually only where it concerns real assets.

Brokers can assist their business-owner clients by helping them present to the private-equity investor how the business can expand its reach, double its sales or dramatically increase its production with an infusion of capital. To best attract private-equity investors, the presentation must be short, cover the big picture and discuss the structure in detail. If the business is core, supportable and well-researched, then investors often will listen. 


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