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How micro-cap investor Shore Capital sailed through Covid upheaval to close three new funds

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The Covid-19 pandemic has proven to be a difficult time for many. In the private equity space dealflow slumped across major markets, and those firms who chose not to scrap or postpone fundraising had to take on the challenge in unprecedented ways. Far from struggling amid the chaotic environment, Shore Capital Partners managed to pass $2bn in capital under management thanks to a triple fund close this summer – and sealed the most deals in 2020 across all private equity firms according to Pitchbook. Founder and managing partner Justin Ishbia explained to AltAssets how the firm’s distinct focus on the micro-cap market has helped it thrive through the crisis.

Ishbia founded Shore Capital 12 years ago with three partners when he was 31, a relatively young age for buyout house founders. They had similar backgrounds – working in larger, more institutional and well-known funds, but also faced similar problems.

“Sometimes we were looking at deals and our old bosses would say ‘Yes, it is an interesting deal but it’s too small for us’,” he recalled.

They soon realised there was a market gap to be captured. As in any other competitive business sectors, polarization occurs and successful businesses would grow bigger while unsuccessful ones would eventually be wiped out. Successful fund houses would keep targeting bigger fund raises and larger investments while unsuccessful ones would be out of business, so his question was – who does the smaller deals then?

Aiming to fill the gap, they created Shore Capital to specifically target the micro-cap market. The firm raised five $10m funds from individual investors and scored 3x to 9x returns from the investments, despite the economic recession in 2019. It then moved on to its first institutional fund, which was closed on $112m in 2014. Ishbia described it as a “nice part of the traction” when individuals at larger funds started investing in his funds.

100% reups from LPs

Seven years later and Shore has raced to close three funds simultaneously, collecting $686m of LP commitments within four months. All previous investors reupped for the new funds, with the firm’s offerings to two new institutional investors being accepted. Ishbia attributed the success to the firm’s portfolio returns figure and the commitment to their investment thesis.

Shore has made eight exits so far, with an average return sitting at about 5.9x and a 93% IRR, leading the firm to be listed as a top 1% performer among all PE firms.

He said those returns were built on Shore’s thesis of getting stuck into a segment where very few were playing. Over the past ten years, Ishbia had seen larger fund houses getting into the micro-cap market – but none of them have stayed for very long.

The Riverside Company is currently out eyeing up to $1.5bn for its latest micro-cap fund, while global PE major Thoma Bravo set up an $1.1bn Explore Fund last year to make lower mid-market equity investments.

“They are competitive with me for a period of time but I have not yet seen somebody turning away $700m,” he said. “They don’t stay small for the second fund.”

Shore, meanwhile, is sticking to its guns, remaining exclusively focused in deals with EBITDA of between $1m and $10m.

Ishbia said that because the micro-cap business is just a side plate for the global buyout majors, it does not necessarily get the best execs working in the team.

“Would you put your best athlete on the small deals? They are all awesome people but you put your brightest people on the most critical deals and not the experimental first-time fund,” he said.

And their commitment to the micro-cap segment also brought confidence to business owners.

“If it’s my baby and my company I would really want to partner with someone who does this day in and day out. If you have a heart surgery, do you want a surgeon who had done it 1,000 times or five times?” he said.

Most active global PE firm

Shore said its relationships with business owners allowed it to do 177 deals in 2020, making it the most active global private equity firm that year according to research and data company Pitchbook.

Ishbia said the pandemic had actually accelerated the market movements. “It expanded people’s minds with possibilities,” he said.

He recalled the days before Covid-19 where a generation of business owners had only experienced a bull market. Many business owners, especially the ones founded after 2010, took it for granted that the businesses would generate a rising revenue over time and were not putting them up in the market.

They now realised that all businesses have risks, he says – and in the extreme cases, such as shutting down for several months without any revenue, returns are not guaranteed and it might be better to have a partner.

Ishbia said micro-cap companies would usually be treated as an add-on for bigger firms, but Shore is instead treating them as platform businesses.

He said that although bigger buyout firms can usually provide a higher cash offer, entrepreneurs will typically be left with a more minor ownership in the company, whereas Shore may offer their partners a lower cash deal but a higher equity interest and management opportunities in the company.

Someone who is planning to retire might go for the higher cash offer, he continued, but if the owner decides there is still “gas in the tank” for the business to grow, he might be more inclined to partner with Shore.

“We always have this conversation with the business owners,” he explained. “Unless you are planning to spend all $3m in cash tomorrow, you are going to invest it. Where will you best invest it? In your own company with a team behind you, or put the cash to your wealth manager to invest in the public market?”

Similarities between sectors

Shore’s new fundraises consist of three sector-specific funds. It collected $366m for Shore Capital Healthcare Partners IV, $213m for its debut Business Services Partners Fund and $107m for its first dedicated real estate vehicle.

Shore’s portfolio companies mostly cluster at $5m to $25m EBITDA, often with similar requirements such as the need to focus on SEO marketing and inventory management.

The firm hires experts to oversee specific business management functions across all of its portfolio companies, to make sure they get the support they needed.

Following the same logic, Ishbia shared some common themes the firm would be investing in through the different funds – and being more consumer-oriented is one of them.

In the healthcare space, Shore is looking to invested in tele-health and technology for urgent services, bringing the tech-laggard healthcare sector up to speed in terms of convenience. Ishbia also finds the trends of opioid addiction, mental health and orthodontics interesting investment opportunities.

In the business services side, pest control would be one sector that the fund will be looking into, with Ishbia saying global warming had encouraged pest reproduction, while regulatory issues including fire, water and safety issues will also be on the radar.

The real estate fund, meanwhile, will focus on veterinarian properties.

“The microcap market continues to be underserved, which we are changing,” Ishbia said. “Our playbook supports founders and entrepreneurs with oversized resources from our operations and investment teams.”

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