The key to finding the right investor in the mid-market sector

Adjusting to the macroeconomic environment, finding successors, generating growth, safeguarding jobs, driving technological innovation and all of this under the cap of ESG factors – there is no doubt that the mid-market sector is facing a wealth of challenges. A strong financial partner, whilst not a cure-all, is definitely a good start, helping companies tackle whatever issues they encounter.

To give entrepreneurs and leaders of mid-market companies an idea of how to find the “right” investor, Thomas Weber, Managing Director of Deutsche Beteiligungs AG responsible for Business Development, shares insights from his day-to-day work and explains what really matters. 

The German Mittelstand is still up against it in 2024. Companies are having to up their digitalisation game and realise ESG investments, whilst navigating a tense geopolitical situation and macroeconomic challenges. How can an investor help?
Even demanding market environments tend to offer promising growth opportunities – our experience has corroborated that. It is also fair to say that challenges such as the digital transition and sustainability fuel potential growth. Why? Obstacles that are hard to overcome, such as digital transformation processes, can lead to some market participants being driven from the market. The companies that manage to survive are strong and will be able to increase their market share. This is where we circle back to private equity investors like DBAG. We have been part of these and other processes uncountable times since we were founded almost 60 years ago, and have accompanied transactions of various magnitudes. More than 400 investments have helped us arrive at where we are today: in a position to share our broad-based experience with the mid-market sector. An interdisciplinary concept comprising smart capital, a team of investment professionals and hand-picked experts from various industries and sectors characterises our approach. We work hand in hand to build on the success of each company’s business model and develop a value appreciation strategy that we then implement with the management team, for example via our proprietary buy-and-build approach that enables us to leverage a company’s potential either by consolidation or by complementation. But it’s not just a broad range of experience that DBAG brings to the mix; we can also draw on a wide range of potential financing instruments, meaning that in our Private Equity Investments segment we are able to manage investments in the magnitude of 10 to 220 million euros. We are also able to realise investments funded from our own financial resources. And finally, the majority takeover of ELF Capital Group has allowed us to close the gap between private equity and private debt, making us an ideal financing partner for SMEs and a platform for holistic financing opportunities.

The increasing volume and absolute number of transactions shows that private equity companies have proven their worth to the market. Could you elaborate on this development and tell us what, in your opinion, are the drivers?
First of all, I absolutely agree. Private equity has definitely reached the mid-market sector. I would like to point out though that this has been a lengthy development, especially in Germany, that unfolded over many decades. Whilst 2004 saw 20 MBO transactions with a volume of almost 2 billion euros, that number had increased by 70 per cent, to 34 MBOs, in 2020. The same goes for transaction volumes generated in our sector, which skyrocketed by over 92 per cent during the same period. According to the buyout market study conducted by DBAG and German industry magazine FINANCE, in 2023, financial investors structured 34 transactions with a volume of 3.9 billion euros in Germany. Reading between the lines, one thing is obvious: private equity comes with the clear advantages of offering smart capital, expertise and experience – and above all trustworthiness. Next to financial strength, the latter is probably the most important factor for our business, especially in view of the number of companies seeking succession arrangements. According to a KfW study, around 560,000 of the 3.8 million German SMEs are looking to find successors by 2026. And 45 per cent of all SMEs are considering an external buyer, underscoring that the mid-market sector has (increasingly) come to accept private equity as a valid option. That is a good thing, seeing as the lack of suitable successor candidates, driven by decades of low birth rates, is probably the largest challenge for SMEs yet. In other words, high demand is meeting low supply, and in addition, around one-third of all SME entrepreneurs is 60 years or older, three times more than 20 years ago. This is where DBAG comes in: we work hand in hand with the mid-market sector to not only preserve, but also increase value(s) in the long term, and make succession arrangements for companies – a win-win situation for all parties involved.

Is there anything entrepreneurs can do to prepare for an investor?
Entrepreneurs should ask themselves which path they want their company to take. The answer will determine whether a strategic investor, such as a competitor, or a financial investor is the better choice. A strategic investor will generally buy up the company and manage it under its own brand. Without wanting to sound too dramatic – if you want to keep your company’s legacy alive, a financial investor is probably the better choice. Sure, it comes with changes, but they will be made in close consultation with the former shareholders. Financial investors don’t “only” contribute money; as previously mentioned, they also provide smart capital, i.e. funds with the added benefit of knowledge, expertise and an extensive network. Within this context, entrepreneurs should also think about the financing instrument that seems most appropriate for their company: a controlling investment by a private equity investor, a non-controlling investment with funds from the financial investor’s own financial resources or a private debt solution?

Does DBAG focus on certain sectors when looking for new investments? 
Our portfolio composition reveals that we are interested in companies that (a) are well established in their market and (b) characterised by high growth potential as well as attractive products and services. We also invest exclusively in companies that can fully participate in the structural tailwind of their sector. The IT services and software sector is a good example; it has gained strong traction due to the digital boom, and prospects are promising, which is why one of the funds we advise made our portfolio’s seventh investment in this high-growth market in July 2023, acquiring a majority stake in AOE, a leading service provider for agile software development with a focus on customised business solutions. The situation in the renewable energies market is similar, with DBAG realising an investment in this sector via Avrio Energie, a best-in-class operator of renewable energy plants, alongside a fund we advise, in July 2023. Historically, DBAG was mainly invested in industrial companies, including both IndustryTech companies and industrial service providers. However, we have broadened our investment focus in past years, expanding it to the broadband/telecommunications, IT services and software, and healthcare sectors. After recognising the potential of the Italian market several years ago (especially in Northern Italy which, like Germany, counts a large share of family-owned and mid-sized enterprises), we have also grown in geographical terms, now operating not only in the Germany, Austria and Switzerland region, but also in Italy. As such, we have already structured three new investments in Italy and were able to realise our first disposal in the country (Pmflex), confirming that our strategic focus is bearing fruit.