Investing in Innovation: Private Equity Firm Lotus Innovations Provides Capital Beyond Start Up

By: Margaret Rea

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.