Small and medium-sized businesses represent 99 percent of all businesses in this country and employ about half the workforce. Despite the large size of this market, due to the investments in these companies being time-consuming to find, make and manage, larger asset management firms are generally not well equipped to provide them with capital. The most common source of capital for small and medium-sized businesses is niche funds as well as personal and family savings.
“Star Mountain built a specialized investment firm, bringing large market expertise to address the challenges and opportunities of investing in and strategically helping guide and grow these businesses,” says Brett Hickey, Founder & CEO of Star Mountain Capital, an asset management firm focusing exclusively on what is referred to as the U.S. lower middle-market. “You need capital for organic growth as well as strategic acquisition growth, particularly in a market downturn.”
Barriers to access
Small businesses can be overlooked by investors because they are hard to access in a scalable and institutionalized manner.
“It’s a very large market,” he says. “With smaller companies you get innovation, you get the drive, you get passion, and historically that’s what creates opportunities for investors. It’s a lot easier to grow a company from $20 million to $100 million of revenue versus growing a company from a $1 billion to $5 billion of revenue — but that’s a 5-fold growth in either case. And the market inefficiency of the smaller company marketplace creates the opportunity to generate higher returns.”
Another challenge small businesses face when seeking capital for growth is simply identifying a good partner.
“There are a lot of different types of investors out there,” Notes Ron Gaboury, CEO of Yorktel, one of Star Mountain’s portfolio companies. “To find them, talk to your accountant or your attorney because they work with other companies and have been doing it longer than you. You can also ask other companies, what they’ve done, who they’ve dealt with.”
Gaboury warns that small businesses have to do their own due diligence. “You have to interview that investor just as much as they’re interviewing you,” he says. “You want to make sure they can understand what you do.” You also have to think beyond your immediate needs, which means knowing that a potential investor has the capacity to be flexible if you need more money later.
There’s no shortage of pitfalls. “Don’t get crazy with forecasting,” warns Gaboury. “It’s something of an art — you need to forecast to attract investors, but your forecast needs to be realistic. Beware of encroachment in the use of capital — using it for something other than what it was originally raised for,” he adds. His final advice is simple: “Wide-open communication,” he says. “Be an open book. Be direct. If you build trust, your investors will be there for you.”
The benefits of investing in small and medium-sized businesses go beyond money, according to both Hickey and Gaboury.
“Value-added lending means providing more than just capital,” explains Hickey. “You have the ability to impact job creation and impact society much more than if you’re just buying a public stock. For example, Star Mountain has a specific impact or ESG (environmental, social, and governance) initiative, which includes educating business owners on the benefits of having a diverse board, having a diverse executive team, and having strong governance.”
“Lenders can bring knowledge from other businesses,” Gaboury adds. “And then they can really help the governance around the administration of the company itself. They sit on many different boards and they’ve seen it all and that definitely helps.”
There are more resources available to small businesses than are immediately obvious — if you can find the right partner. “Time and money always have trade-offs and competing interests,” Hickey says. “How to optimize your time and money is what we are experts at.”