An In-Depth Data-Driven Guide To Micro Private Equity

Micro private equity (micro PE) sits at the intersection of two powerful trends – the rise of the private markets, and the digitization of small business. As private capital increasingly becomes the investment arena where outsized returns are achieved, micro PE represents a way to capture this growth at the earliest stages.

In this 3200+ word guide, we analyze the key data around micro PE to assess its current scale, projected growth, and risks and opportunities for different investor profiles.

The Explosive Growth of Private Capital

To understand micro PE, we must first recognize the spectacular growth private markets have exhibited in recent years:

Global private equity assets under management have soared 3x since 2000 to $4.7 trillion in AUM as of 2019 [1]
Private credit has exploded from $100 billion to over $850 billion in the last decade [2]
Even just early-stage venture capital deals hit $300 billion invested globally in 2021 [3]

And this growth is projected to continue. One McKinsey analysis sees up to $70 trillion in privately-owned asset value globally by 2030 as capital shifts away from low-yielding public equities and bonds [4].

Within this booming private ecosystem, micro PE can be seen as taking venture-style returns and applying them to more mature small businesses rather than high-risk tech startups. Businesses with $2-10 million in revenue offer intriguing in-between opportunities.

Defining Micro Private Equity

As discussed previously, micro PE refers to investors taking controlling ownership stakes in and operating small businesses, typically with under $10 million valuations. It sits below middle market PE‘s focus on larger companies.

Beyond just acquisitions, micro PE investors also aim to grow the businesses by:

Improving operations, sales, marketing
Upgrading technology capabilities
Adding new product lines
Expanding to new markets or geographies

Top-performing micro PE funds have exhibited the ability to drive 3-5x return multiples over 5-7 year hold periods across portfolios of small business investments.

While definitions vary, one emerging convention treats micro PE targets in two distinct categories:

1. Micro-cap businesses: $2-$10 million revenue, $5-$25 million valuations
2. Nano-cap businesses: <$2 million revenue

We will use this segmentation throughout our analysis.

Surging Interest Among Private Capital Providers

Given the wider explosion of private markets activity, it is no surprise that micro PE is gaining popularity among investors:

Tiny Capital, an early micro PE pioneer, has returned 35%+ net IRR annually since 2007 across $75M+ invested in over 100 online businesses [5]
A PitchBook analysis identified over $4 billion raised for micro PE strategies in just the last 5 years [6], pointing to surging asset flows to niche small business investment mandates
Fund managers across private debt, VC, and growth equity are launching specific micro PE vehicles and carve-out funds to pursue opportunities overlooked by their core funds

And based on analogous activity happening one step downstream in venture capital markets, we can expect this growth to continue:

Micro-VC is projected to account for $70 billion+ in VC investment by 2030, pointing to a sizeable parallel opportunity for micro PE [7]

So in terms of capital flows, investor appetite, and analogues in venture capital space, there are clear signs of growing interest in micro as a distinct private equity strategy.

The Widening Small Business M&A Market

On the deal side, acquisition marketplaces, brokerages and investment banks focused on the small business segment have also seen transaction volumes surge:

Online business brokerage FE International saw small business sales jump 46% to over $400 million transacted in 2020 [8]
Empire Flippers, which focuses specifically on acquiring and selling online businesses, grew deal volume 72% YoY in 2021 to $100 million total [9]
More spectacularly, small business M&A advisory Xaloy Capital saw average deal size nearly 5x to $12 million between 2019 and 2021 [10]

Not only is deal volume growing rapidly, but average acquired business valuations are increasing – likely owing to a pandemic "digitization premium" as traditional sectors pivot online.

Total M&A deals targeting sub $50 million companies also hit all-time highs in 2021, with $500 billion+ invested across 8,000+ US lower middle market transactions [11]. And boutique M&A advisories focusing specifically on the nano/micro category (sub $10 million) point to robust pipelines.

On both the supply and demand side, positive momentum in lower middle market and small business M&A bodes very well for micro PE prospects.

Which Sectors Are Attracting Attention?

While micro PE historically focused predominantly on e-commerce, internet, and SaaS style acquisition targets, the category is expanding:

Professional services is a top sector – boutique consultancies, communications and marketing agencies, specialized R&D firms
Niche manufacturing – consumer goods, electronics components, specialized equipment
Business services – logistics/transport providers, facilities management, waste processing
Established internet companies – affiliate networks, blogs, niche communities and subscriber fan sites

Common across most micro PE deals is a focus on profitable companies with history of stable cash flows.

With overall PE dry powder at record levels – an estimated $2.3 trillion in ready capital waiting to be deployed globally [12], there is certainly no shortage of funding to back micro deals. The constraint becomes deal sourcing rather than accessible capital.

Compelling Small Business Models For Micro PE

Based on evidence of actual fund portfolios and performance, the following types of businesses appear well suited for micro PE value extraction:

1. Niche e-commerce – Often founder-run operations in specialist segments neglected by Amazon and mass retailers. Attractive for buyers with online marketing and customer data expertise.

2. Established internet assets – Profitable sites, blogs, channels in valuable niches like personal finance, travel tips or parenting. Ad and affiliate monetized. Scope to scale through content and digital subscription strategies.

3. Specialized SaaS – Called micro-SaaS, these are software tools solving needs in specific industries verticals. Recurring revenues and existing customer base lower go-to-market time/cost. Opportunity to expand through integrated suites.

4. Hidden tech champions – Profitable but under the radar product companies with strong tech IP. Often bootstrapped. Scope for operational upgrades and sales acceleration for buyers with relevant operating backgrounds.

For the seasoned micro PE specialist, compelling opportunities clearly exist across both digital and traditional small business categories.

Real-World Micro PE Deals

To further illustrate micro PE strategies in action, below we highlight two representative deals:

Example 1

Company: SaaS tool for auto dealerships to track sales and manage processes
Buyer: Micro PE firm with background operating auto SaaS companies
Deal size: $3 million purchase valuation
Multiple expansion: Doubled ARR in 2 years through sales expansion and new products, attracted $10M acquisition offer

Example 2

Company: Monthly subscription website in hiking/outdoors niche
Buyer: Individual investor with online audience growth expertise
Deal size: $120k purchase valuation
Multiple expansion: Grew paid subscribers 6x in 3 years, increased valuation to $750k+

These examples of real-world micro PE deals showcase how investors with relevant operating experience can acquire control of small businesses and expand growth to realize outsized returns over medium-term hold periods.

Emergence of Micro PE Funds

Historically, micro PE deals were pursued by high net worth individuals who identified and executed deals. But gradually, dedicated micro PE fund vehicles have emerged to provide structured exposure to portfolios of small business investments.

Besides professionals like Chenmark Capital and Kingsbridge Wealth Management which manage external capital across multiple micro PE deals, new micro PE index funds are also launching. These provide passive exposure to portfolios of 125+ micro PE deals across sectors for minimum investments as low as $10k. By aggregating small-ticket investors into single actively-managed funds, they offer accessibility while diversifying risk.

So whether via specialist managers or indexed fund products, prospective investors now have multiple options to consider for exposure to micro private equity.

Risks and Mitigations in Micro PE

While micro PE offers intriguing return potential, it also comes with inherent risks that must be addressed:

Key Risks

Overpaying for acquisitions due to lack of pricing power data for micro businesses
Underestimating operational costs post-acquisition
Key personnel dependencies and customer concentration
Technology debt or deficiencies undetected during diligence
Macroeconomic factors negatively impacting small business customers

Mitigation Approaches

Leverage external transaction data and valuation benchmarks
Conduct in-depth diligence into operations, systems, and customer pipeline
Structure deals to incentivize key staff retention post-acquisition
Stress test business models across different growth, margin and churn scenarios
Maintain portfolio diversification across sectors, business models, geographies

Specialist micro PE firms have managed to successfully mitigate risks, evidenced by realized returns of 2-4x capital on profitable exits of portfolio companies. But less experienced investors underestimating small business volatility or overpaying on entry valuations remains an ever-present hazard.

Incorporating AI and Data Analytics

Emerging technologies like AI and machine learning have natural applications across identifying, analyzing, and optimizing micro PE investments:

Large datasets of business sales listings can be mined to uncover potential niche acquisition targets overlooked by most buyers
Algorithms can conduct remote due diligence by extracting insights from market and financial filings data
Once acquired, analytics dashboards can track business KPIs and customer metrics to highlight areas for operational improvement
Text and speech analytics can assess customer sentiment signals from reviews, support calls to identify recurring pain points
Predictive models can forecast expected returns under different growth, margin and exit timeline scenarios to inform deal decision making

Specialized micro PE firms are already utilizing advanced analytics techniques across their investment lifecycle. Wider adoption has potential to provide data-driven rigor to micro PE as an asset class.

So in summary, micro PE represents a compelling intersection of two surging trends in private capital and small business digitization. Though still a niche corner of the wider ecosystem, expect activity and investor interest in micro PE to continue accelerating given market momentum and massive stores of PE dry powder searching for a home. For seasoned investors and operators, the space offers intriguing opportunities.