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Middle-market PE firms selling minority stakes to outside investors
In the past, large bulge bracket private equity firms like the Carlyle Group, the Blackstone Group and Providence Equity Partners sold minority stakes to outside investors as a method of raising capital and fueling growth. Recently, this phenomenon has migrated down to middle-market private equity firms, with those firms increasingly selling minority stakes in the firms themselves (as opposed to limited partnership interests in their fund vehicles). Why?
 
Capital to grow
Middle-market private equity firms, especially those with smaller portfolios and less operating history, generally do not keep a lot of cash on hand. Sale of a minority stake gives private equity firms a balance sheet boost and instantly deployable capital, providing the resources to pursue deals they otherwise could not take on. Furthermore, similar to firms in other industries that recently struggled to grow organically, private equity firms struggled to grow solely from returns at the fund level. The capital raised by selling a minority stake allows private equity firms to seek add-on acquisitions for portfolio companies, explore other business lines, test novel investment ideas that they can later apply at the fund level and acquire other private equity firms. Finally, by selling a minority stake, private equity firms can raise capital without the headache and expense of a public offering.
 
Generational transfers
As the middle-market private equity industry matures, the general partners of firms founded in the 1980s and 1990s are transitioning out. A minority stake sale at the firm level provides these general partners with liquidity and lowers their risk profile. Moreover, as the old guard general partners transition out of the firm, younger general partners may have trouble covering their capital commitments at the fund level. Selling a minority stake can supply the capital necessary for the next generation of general partners to raise new funds.
 
Deepening ties with investors and limited partners Historically, minority investors in private equity firms have been current or former fund limited partners. Selling a minority stake in the firm to a long-time fund limited partner allows both the private equity firm and the limited partner to develop a deeper institutional tie. Private equity firms look for minority investors with industry expertise, deal sourcing networks and value beyond their capital. Limited partners are attracted to minority investments in private equity firms because their investment maintains a steady stream of income from profits and distributions and avoids the fees associated with investments at the fund level. Becoming a minority investor at the firm level could also open up additional investment opportunities at the fund level. Minority investors must be aware, though, that capital invested at the firm level may be tied up for long periods of time and, unlike investments in a fund, there is no express future liquidity event to look forward to.
 
As the middle-market private equity industry becomes increasingly competitive, more and more middle-market private equity firms will look to raise capital through minority sales. This capital will help the next generation of general partners raise funds, close deals and grow their firms.

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