Micro-PE is, as the name suggests, an investment approach similar to traditional private equity, but at a much smaller scale.
It involves the acquisition, management, and potentially sale, of small businesses (‘micro-cap’ firms, in investor parlance), typically at valuations below $5-10mm.
How Is Micro-Pe Different from Being a Founder, or An Angel Investor?
Like traditional private equity, micro-PE investors are looking for profitable companies with an established value proposition, even if in a niche or small-scale market.
Typical values for a micro-PE transaction could be from a few thousand dollars on the very low end up to several million dollars at the high end.
Unlike entrepreneurs, micro-PE investors are not founders, they acquire companies and brands from founders.
And differently to angel investors, a micro-PE investor is not providing passive capital to help the business grow aggressively – rather they are acquiring control of the business with the intention of either using it as a cash cow, or improving and growing its operations to sell it on at a higher price.
Micro private equity can either be structured formally as an investment fund (if multiple investors are involved), but is more often simply a business approach followed by a single investor who might otherwise be an entrepreneur or business angel.
The business being acquired must have its own brand and be operationally independent – buying a franchise is not considered micro-PE.
It is worth adding that micro-PE investors are also often not managers – they do not directly run the business day-to-day, and, for larger acquisitions, will often expect professional management to be in place at the time of sale.
However, similarly to business angels and traditional PE, micro-PE investors often will provide strategic advice, key-person recruiting and similar high-impact activities.
Why Is Micro-PE Growing Now?
Traditionally, small business owners faced very limited avenues for the disposal of their businesses.
Options were often to close the business or make a trade sale to a major chain or local competitor.
The internet has rapidly changed this equation.
Several online business brokers or marketplaces now provide listings of small businesses for sale in almost every industry, from construction to retail, as well as the legal and administrative support to complete the sale.
This improved liquidity and transparency has led to the emergence of micro-PE – investors who are financially motivated, not industry specialists, buying small businesses for cash flow.
It is now possible to buy even very small ‘mom and pop’ businesses in dozens of countries around the world.
The second way the internet has enabled micro-PE is by creating web-based ‘SaaS’ and ecommerce business models that are highly scalable, with high gross profit margins, that can be managed from anywhere.
Together with the fact that web-based businesses are generally run by digital natives and those who are comfortable in online niches and expert in digital products, this has vastly increased the number of businesses available to buy.
And since many SaaS businesses are subscription-based, with more stable and predictable revenue figures, they are also more attractive to investors.
Who Should Become a Micro-PE Investor?
While micro-PE is accessible to individuals with five or six figures in cash to invest, it can be especially attractive to those with specialised skillsets which can be applied to add value to the acquired companies, such as in sales, marketing, design, technology or finance.
A founder, perhaps with specialist industry knowledge, may be able to get a small business off the ground.
But they may not have the desire or skills to fully commercialise and scale the business – for example by growing beyond a niche market, taking advantage of new technology, providing substantial additional capital, or understanding optimal financing structures.
In some instances, a founder may also be looking to exit a small business for personal reasons – such as retirement.
A micro-PE investor might be able to unlock value for the company and thus increase its value.
Other examples might be micro-PE investors who want to expand brands from one product market, geographic region or sales channel to another – for example, a micro-PE investor with expertise in digital marketing and customer analytics may be able to add value by optimising a company’s online advertising spend, enabling it to grow faster and enter new markets.
The Technical Details of The Acquisition Process
How much to pay for a very small business is in the eye of the beholder.
As a very general rule, for a business experiencing modest, steady growth, 2x annual EBITDA is a good low-end number, whereas 5x would be considered high.
The key point is that the business should have regular monthly recurring revenue (MRR) without wild swings.
Typically the business should be at least 12 months old and ideally 2-3 years, with formal financial statements to enable due diligence.
Due diligence is an essential part of any micro-PE transaction, just as in any investment.
However, given that micro-PE transactions cannot be easily reversed, it is especially important to check factors including the real cash revenue numbers, cash costs, technology setup (and ideally the codebase itself in a digital business), and operational considerations such as the customer service process.
Key questions to ask include: Do the claimed revenues match up with cash receipts?
Do the cash expenditures line up with costs?
Is the infrastructure robust?
Is the technology setup built to scale?
How much manual customer service is involved?
As part of the due diligence process, it is essential to understand the involvement of the owner/seller in the management.
For very small businesses, this may be considerable, whereas for more established firms, there may already be employees or contractors to handle day-to-day operations.
If the buyer does not intend to be involved with the active management of the business themselves, it is vital to price in the cost of hiring appropriate staff, at market rates, to undertake the work currently done by the seller.
What About Micro-PE Funds?
So you’re interested in micro-PE but you don’t have the time or money to be a professional investor just yet.
Or, perhaps you’re a small business owner looking for an exit.
Well, you’re in luck!
A micro-PE fund industry has been developing to enable exposure to micro-PE as an asset class.
The grandfather of the industry is Tiny Capital, started in 2007, and focused on online and SaaS companies with professional management in place.
Other funds, such as Chenmark, will acquire both online and physical small businesses.
In recent years, platforms are being established to enable individual investors to invest in these funds at minimal cost, gaining diversified exposure and professional investment expertise without the costs, risk and time commitment of direct investment.
Micro-PE is an exciting and fast evolving industry that places the tools of Warren Buffett or Carl Icahn in the hands of small private investors.
The continuing growth of online business, and developments such as Generative AI, are likely to herald major changes and opportunities for small businesses in coming years.
While not suitable for everyone, micro-PE offers investors exposure to a historically underserved asset class, one with much lower average valuations than among public companies.
With capital increasingly globalised and stock and bond markets increasingly saturated, micro-PE may represent one of the last truly undiscovered frontiers of investment, with all the potential that implies.