Private equity funding: looking for investment targets.

• Author: Dimitriou, Jim

The recent recession produced numerous consequences. Rampant unemployment, plunging stock values, greatly reduced product demands and an over-abundance of financially strapped companies combined to create a risk-averse marketplace devoid of a steady flow of new capital.

Throughout the past two years, investors of all types--private equity, venture capital and angel investment sources--have shown a greatly diminished interest in overly leveraged transactions. Although the record for the most lucrative buyout has been broken repeatedly over the past 10 years, many companies--especially those representing the industrial and retail marketplaces--have had a great deal of trouble finding new methods of funding since the economic decline began in 2008.

Conversely, the downturn did not tarnish investor interest in several categories, including aerospace and defense, energy and health care. In fact, this was stated in a recent article in Becker's Hospital Review, "Private Equity Funds Are Changing the Face of U.S. Hospitals." And, they're doing so by increasing their interest in nonprofit organizations, which have been challenged in their efforts to gain traditional funding to subsidize new information technology acquisitions and prepare for the costly onslaught of health care reform mandates.

In addition, profitable hospital networks have also shown a growing interest in gaining funds to expand services into new communities through the purchase of non-profitable competing facilities. A recent Pepperdine University survey revealed that 11 percent of private equity investors polled intended to invest in health care--a significant increase over last summer's results, when just 4.8 percent of PE managers reported an interest in health care investments.

Searching for the Right Investments

Similarly, other conditions and variables have demonstrated a ripening marketplace that has private equity fund managers actively searching for the right investments on behalf of clients. For instance, in the early 2000s there were approximately 3,000 PE funds supported by about $150 billion in capital in the United States.

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In contrast, new reports estimate there are now more than 4,000 mature investment portfolios with firms worldwide accumulating nearly $500 billion in "dry powder," or cash reserves kept on hand to cover future obligations.

PE fund managers that have been sitting on this extraordinary amount of capital for the past few years are now beginning to overcome their fear of risk and are actively searching for deals that will maximize client investments and legitimize their annual performance and management fees.

The 50 largest funds account for approximately 70 percent of all PE funding. Of course, these banks and funds typically only focus on high-profile deals valued in the billions of dollars with major corporations.

Lower-middle to middle-income companies have been traditionally underserved, given that there are normally significantly more sellers than experienced PE professionals who truly comprehend the potential of these performers. However, this trend is rapidly dissipating as PE managers are increasingly expanding their search for acquisitions with enterprise values ranging from $10 million to $500 million per transaction.

This is especially true for organizations that can satisfactorily demonstrate high levels of customer service, the ability to respond to challenges and leadership qualities that inspire loyalty, forward thinking and the potential to drive greater profits at the next level.

A recent survey of general managers by national accounting firm EisnerAmper LLC revealed that private equity firms are "racing to shape up portfolio companies to entice limited partners to put...