Hidden gems: How German small-cap GPs source deals

Katharina Semke
16 March 2016

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Deal sourcing in the small-cap sector often requires private equity firms to put more effort into finding targets. Katharina Semke finds out how GPs in the DACH region are approaching small-cap origination

It is common knowledge that most deals in the mid-cap sector in Germany are sourced via M&A intermediaries nowadays, which usually aim to sell a company through an auction process. While GPs focusing on larger mid-cap companies can rely on dealflow from those channels, the survival of private equity investors targeting small-cap companies often relies on their resourcefulness. However, the way they approach deal sourcing can vary from firm to firm and often requires more work.

Munich-based private equity house Auctus has a larger-than-usual team committed to deal sourcing, according to its CEO and managing partner Ingo Krocke: "GPs operating in the mid-cap or large-cap sector can hire more staff and commit a whole team to deal origination. Many teams with small funds think they can't afford this, but we think differently." Considering most of Auctus's deals are valued below €25m and its last fund closed on €230m, the GP has a solid 18-strong team – with plans to hire more.

It is important to make as many contacts as possible. Opportunities will emerge from some of them, but this can often take several years" – Ingo Krocke, Auctus

Fewer staff means small-cap firms may also rely strongly on intermediaries. However, for Krocke, the best chances to score a proprietary deal are in the small-cap sector. That is why his business has focused on exclusive and proprietary buyouts: "We have a dozen buy-and-build sectors per year where we do research and approach companies. It is important to make as many contacts as possible. Opportunities will emerge from some of them, but this can often take several years." The GP also makes an effort to visit conferences and fairs, to be in touch with sector experts. Krocke claims that his firm's resources and long-term focus make deals happen that it might otherwise have missed out on.

Diamonds are forever
Ufenau Capital Partners, on the other hand, strongly relies on its investors – which it calls "industry partners" – of which many are current or previous owners of businesses themselves. The GP started as the deal-by-deal club of a private investor group. Following its change in strategy in 2010, many of them are currently investors in Ufenau's funds. The private equity house made an effort to establish a strong relationship with them, on the grounds that an LP can increase its returns by supporting the GP.

Ufenau starts its investment process by surveying its investors, asking which asset-light sectors they would like the GP to invest in. It then conducts research on potential target companies. Usually, Ufenau approaches possible target companies directly. Despite the occasional M&A-intermediated deal, Ufenau's managing partner Ralf Flore says the mid-cap sector's strong reliance on auctions would be deadly for small-cap GPs: "We source most of our deals proprietarily. This is, of course, more tedious, because the company owners have to be convinced, but we found that our industry partners can be very helpful at that stage. We take them to meetings with us. Being business owners themselves, their words weigh more heavily with an entrepreneur than those of a private equity firm."

Ufenau's last deal was sourced in a proprietary manner. The GP acquired an 85% stake in German claims management and property insurance provider Faircheck Schadenservice in November 2015 after actively looking for a deal in the sector and approaching management.

It is important for us to keep a tight relationship with M&A advisers, otherwise they forget what we are looking for" – Johann Herstatt, Seafort Advisors

Seafort Advisors has a different sourcing strategy to Auctus and Ufenau. The Hamburg-based investor tries to maintain a close relationship with M&A advisers and other parties that participate in a sale process. "It is important for us to keep a tight relationship with them, otherwise they forget what we are looking for," explains partner Johann Herstatt.

Despite their strong ties with the M&A community, Seafort also tries to avoid auctions if possible. "We tell owners that an auction process gives their competitors a chance to gather information about their company, which might cause a disadvantage for the business," says Herstatt. A quiet sale, despite the possibility of a lower exit price, might therefore be the more sensible option for owners, according to Herstatt.

The strategies outlined above show that those GPs who operate in the German small-cap sector, despite their – sometimes reluctant – participation in auction processes, make an effort to find deals off the beaten track. Being out there as an investor and interacting with entrepreneurs on occasions that do not solely focus on a buyout or investment scenario certainly helps with a crowd of business owners who still eye private equity with suspicion.