Siguler Guff opts for more direct investing in smaller markets

Siguler Guff's Small Buyout Opportunities Fund IV, closed in December at $1.57 billion-plus, will invest in funds and direct activity on a 50:50 basis.

Siguler Guff, which raised more than $1.57 billion for a fourth small buyout fund, is doubling down on its 14-year niche strategy in part by creating more room for co-investments.

“We started the strategy in 2006 as an early player in a market contending with inefficiencies,” Kevin Kester, who heads Siguler Guff’s small business investment group, told Buyouts. “Today, while others move up-market, this is where we want to continue to play.”

Siguler Guff in December closed Small Buyout Opportunities Fund IV above a $1.25 billion target to commit more capital to managers investing in small and low-mid-market companies. Most of the limited partners were institutions in North America, Europe and Australia. Existing LPs re-upped at a rate of more than 90 percent.

Siguler Guff mostly makes commitments to buyout funds sized $100 million to $300 million. While outperforming larger-cap funds, Kester said, small funds face challenges raising new capital, chiefly because of LP policy restrictions on allocations.

By enabling LP investments in small buyout funds, Siguler Guff has become an essential capital source. To date, the firm has committed $2.7 billion to 93 pools, often as an anchor investor. Fund III, Kester noted, led commitments for three-quarters of portfolio funds.

Siguler Guff also supports emerging managers, forming joint ventures with first-time funds in which it is the sole LP. The goal, Kester said, is to help managers develop a track record, execute on their own and eventually raise a next vehicle.

Investing directly

Siguler Guff’s strategy lends exposure to a universe of 350,000 established US companies that fit into the firm’s preferred size range, many of them founder-led. Despite the economic importance of this universe, Kester said, related opportunities have attracted only 10 percent of buyout funds raised over the past five years.

Siguler Guff invests directly in businesses through co-investments with fund partners. The firm has so far committed $1.4 billion to 146 co-investments, giving it minority stakes and often observer seats on boards.

Over time, Siguler Guff has steadily increased the proportion of committed capital going to co-investments. Between Fund I and Fund III, the share rose to 40 percent from 25 percent. For Fund IV, the plan is to invest in small buyout funds and direct activity on a 50:50 basis.

Kester said this evolution is the result of “a lot of success with co-investments,” which are “a major source of alpha in our portfolio.” Fund III generated a 17.4 percent net IRR as of September 2019, a source told Buyouts.

Companies backed directly and indirectly, located in a range of sectors and regions, usually have EBITDA of $2 million to $15 million and revenue of less than $100 million. Siguler Guff relies on fund partners to drive organic and inorganic growth initiatives, Kester said, but also adds value by creating access to its global networks.

Fund IV is expected to invest in about 25 small buyout pools, committing $25 million to $50 million to each. Investee companies will typically be held for up to six years and sold mostly to larger private equity funds and strategic investors.

Anticipating a downturn

The small buyout space has characteristics that set it apart in the broader PE market, Kester said. They include small valuations, as small and low-mid-market companies trade at comparatively low purchase price multiples. There is also more conservative use of leverage, he added.

At present, Siguler Guff’s strategy is benefiting from a US small business community that is investing, growing and hiring at historic levels. Research suggests, however, that members of this community are also among the hardest hit in recessions, which is of concern in a late-cycle economy.

Kester said Siguler Guff “is very cognizant of where we are in the cycle” and is taking steps to prepare for a potential downturn. He noted his group’s strategy was launched just prior to the 2007-08 financial crisis and “came through extremely well.”

New York-based Siguler Guff was spun out of PaineWebber in 1995 as a specialist in niche investing. Along with small business, the firm’s programs include distressed and special situations, emerging markets and real estate.

Kester, who joined in 2004, heads a team of 12 investment professionals. He was previously director of alternative investments with Colorado Public Employees’ Retirement Association.

Action item: Check out Siguler Guff’s ADV filings here.