Unlike most lower middle-market private equity firms that have limited focus, Star Mountain Capital has taken a diversified approach to investing that is more common among larger firms. The New York-based firm invests into established, small and medium-sized companies in three ways: as a direct investor often in the capacity of a lender, as a strategic limited partner through a fund-of-funds program into other lower middle-market funds and, lastly, as a secondary fund investor providing liquidity to limited partners in lower middle-market funds.
We had a chance to sit down with Founder and CEO Brett Hickey and learn what Star Mountain is up to as it readies to raise its next series of funds.
MMR: How would you characterize market conditions today?
Brett: M&A market conditions are strong. In the lower middle market, business owners recognize private equity firms have a tremendous amount of dry powder. As an owner, if you can grow your business just one size larger you can generally command a higher valuation multiple. So business owners are doing M&A transactions to grow their business in order to sell at a higher valuation down the line.
The second thing that’s driving demand in the U.S. is the retiring demographic. There are approximately 60 million Americans between the ages 55 and 70 and another roughly 6 million people entering retirement age every year. These people have businesses to sell and that is also driving demand.
MMR: Why does your strategy of being a limited partner, general partner, and secondaries investor work?
Brett: It helps us maximize market knowledge, deal flow, data, resources, and relationships—all three things optimize the challenges and opportunities of the typically sub $15 million EBITDA marketplace. We try to be a solution-based, and value-added partner, to investors, business owners and other high-quality fund managers. We believe our multiple products structure allows us to optimize value in an aligned manner.
Another reason why we do this is to build better risk-adjusted returns portfolio with more diversity. Investors in our multi-strategy Fund II, for example, gained access to over 150 underlying companies in a diverse, fee-efficient, and highly governed manner.
MMR: Are you raising a new fund now?
Brett: We are raising our third series of funds. We already have subscription agreements being signed and we have had a strong response from our existing investors in our prior funds. We are still in the soft marketing phase providing first bite at the apple to existing limited partners, but we will likely close sometime in the next 12 months.
We have a multi strategy-fund, single strategy funds, and single LP customized accounts. We have funds that give investors the opportunity to invest in direct secured loans with warrants, secondary fund positions, and primary fund investments, without the traditional layered fund-of-fund management fees.
Investors can get diversity under one roof with us in a fee-efficient, highly-managed and risk-reward optimizing manner. Given that these established small and medium-sized businesses represent nearly 50% of the U.S. economy, and given that, based on research, they tend to grow faster and in a less volatile manner than larger companies, we believe that they should be considered as a part of the portfolio.
Our highest volume line of business is our lower middle-market private credit strategy. In some cases, we are in fact investing in would-be competitors. But our view of the world is that we don’t think we can do everything; there are good folks out there who we want to work with to optimize value for our stakeholders. We believe working together can create better portfolios for investors.
MMR: Who are your investors?
Brett: We have a broad range of asset managers working with us, some of whom are the largest publicly traded asset managers like KKR while others are insurance companies, endowments, foundations, hospital plans, pension funds, wealth management platforms, and family offices. Lastly, we have high-net-worth investors as well. Our objective is to deliver top quartile private-equity style returns with more liquidity, current yielding, and a secured loan risk profile. We likely won’t deliver top decile PE returns, but we believe we take a substantial amount of the risk off the table to target top quartile level of net returns.
MMR: Does your focus change as market conditions change?
Brett: I have been a direct principal investor since 2004 and in 2010 I launched Star Mountain. We developed a comprehensive business plan on how to address the opportunities in this market, which is around half of the total U.S. economy. Generally there aren’t large competitors in this space. The banks do not serve this part of the market well. It’s fragmented and labor intensive. We believe opportunities will continue to be driven from the thematic supply / demand characteristics including the retiring baby boomer population and increasing valuations from successful mergers as companies grow in size.
MMR: What’s new at your firm?
Brett: We continue to invest heavily in technology to help better originate, underwrite, and add value to our portfolio companies. A few portfolio company values we bring include helping find, analyze, and integrate acquisitions; helping grow sales including opening relationship doors – where we also leverage the job creation positive goodwill angle from our business and helping further professionalize businesses to help optimize long-term value, including building and managing boards.
Some of our value doesn’t show immediately, but as we have had close to 100 realizations across our platform and we look at our current portfolio characteristics relative to the market, we feel very good about our long-term focused investments in team, product, and technology.
MMR: What’s on the horizon for the industry?
We believe that all markets will continue to get more efficient; however, given the labor intensity and specialization required at our end of the market, it will be slower to evolve and continue to provide a return premium relative to the larger markets.
While the U.S. economy looks quite healthy right now, we try remind ourselves that there isn’t often a clear warning of a market downturn. We believe the next one will come so we continue to operate accordingly, with our defensive lens on in preparation for the potential challenges.