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The Opportunity in Microcap Private Equity
Channelstone believes that the microcap market is a rich, untapped market for private equity transactions.
The microcap market is large with significant growth potential.
- According to the United States Federal Government, small businesses represent 45% of total annual payroll and has generated 60-80% of net new
jobs over the last decade.
Despite these facts, the market for small, established companies remains less competitive than other equity investment alternatives and represents an excellent investment opportunity.
- $100 billion in capital is awaiting investment for large private equity transactions, creating upward pressure on both price and transaction size.
- Institutions have invested significantly less in the microcap market.
- Buyouts of small, established companies are less expensive with better return economics.
The microcap market has a favorable risk/return profile in comparison to alternative equity investments.
- Microcaps often avoid leverage, creating an opportunity to increase returns.
- The microcap market has historically outperformed larger indexes in the long-term.
- Investments in comparable transactions yield internal rates of return exceeding 33% (Stanford University).
Purchasing microcap companies with established operations, customers, and products mitigates execution risk.
- Large percentage of venture-backed startups fail prior to reaching profitability.
Returns are Driven by Growth and Leverage
The combination of sales growth,
operational improvements and
leverage drive returns.
- Growth will drive up valuation by
substantiating business potential
and by giving portfolio companies
access to more liquidity options.
- Leverage will create returns independent
of growth.
- Targeted portfolio companies will
have solid operating performance
and low leverage; at least twothirds
of the acquisition price will
be leverage.
- The company will pay off debt
with current cash flow levels; the
value of the equity will rise by the
amount that the company pays
off its debt.
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Channelstone Investments are Well Positioned to Benefit from Expansion of EBITDA Acquisition Multiples
Channelstone’s acquisitions are typically
purchased at a discounted multiple relative
to larger acquisitions.
If Channelstone successfully grows the
business, acquisition multiples typically
increase. Equity buyers place a
premium on larger companies because
they have:
- Easier access to capital, a platform
for growth and a larger EBITDA
base.
While transaction multiples vary with
industries and are situational, average
microcap multiples for valuations
larger than Channelstone’s targets
are 7.1x.
- Multiple expansion enhances returns
above returns driven by
growth and leverage.
- Channelstone does not rely on
multiple expansion to determine
the attractiveness of an investment,
but total returns materially
benefit from higher exit multiples.
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