Back to Insights

Part I: Why Small Tech Buyout May Be the Most Attractive Opportunity in Private Equity

Article at a Glance

  • Despite current market conditions, we have seen LP appetite for private equity remain healthy given the strong, consistent performance within the asset class
  • Global digital transformation and widespread software adoption has benefited tech buyout, which over the past decade has considerably outperformed broader private equity, allowing many of the tech specialists to scale and raise mega tech buyout funds (>$5B+)
  • As these mega tech buyout funds continue to expand, small tech buyout managers (<$1B) have filled the gap, benefiting from less competition in a massive and growing market
  • Within tech private equity, small tech buyout has been the best performing segment and we believe is well positioned to continue to produce outsized returns, making it the best kept secret within PE

Small is the New Big

Over the past decade, private equity has scaled considerably as investors seek returns in an ever-expanding competitive landscape. This led to the rise of sector specialists, especially in industries with substantial secular growth tailwinds like technology. The global digital transformation coupled with strong returns and LPs’ thirst for outperformance enabled established tech buyout firms to leverage their success into larger and larger funds. While the ultimate consequence of this growth and increased efficiency is unclear, we believe the smaller end of the market presents a unique opportunity for outperformance at an ever-increasing rate.

The Rise of Mega Tech Buyouts

As investors search for returns, capital has continued to pour into private equity. The average size of buyout funds has increased substantially over the past 10 years as private equity has come to account for a meaningful allocation of institutional portfolios.

The average buyout fund size grew from $565M1 in 2012 to $963M1 in 2022. This step-up in average fund size has been skewed by the rise of “mega funds,” or funds with closed commitments of $5B or more; certain GPs have even closed funds surpassing $10B in commitments. In particular, specialist mega buyout funds have scaled significantly, accounting for 62%2 of technology fundraising since 2016.

Despite a turbulent year, in 2022 all mega funds in the US raised $179B1, representing 52%1 of all private equity capital raised. These include tech specialists such as Francisco Partners closing on $13.5B3 for its latest flagship fund and Thoma Bravo announcing it raised $24.3B1 for its latest flagship fund.

It is no surprise, though, why capital has been racing into PE tech specialists. Over the past decade, tech-focused buyout funds have meaningfully outperformed broader private equity, generating IRRs that are 440 basis points higher than the overall private equity market5. As investors, we believe it is critical to look forward in a constantly changing and dynamic market. A natural line of questioning may include “What are the effects of rapidly scaling buyout funds? Will returns persist at historical levels given shifts in the competitive and macro environment?”

Within technology, outsized returns are actually most acute within the small-cap segment. Over a 10-year investment horizon ending in 2021, small-cap, technology-focused buyouts have outperformed the private equity industry as a whole by a whopping 700 basis points5. Further, small-cap, technology-focused firms outperformed all other size segments within technology buyout.

We believe that small tech buyout funds are well-positioned to continue to outperform at an ever-increasing rate, driven by 1) valuation advantages on the buy, 2) attractive growth potential during the hold and 3) efficient and well-capitalized exit markets, leading it to be one of the most attractive segments within the buyout ecosystem.

“Small Buyouts” Defined

As Tech Buyout Funds Grow Ever Larger, Smaller Managers Emerge

The tech buyout space becomes increasingly crowded with investor capital primarily flowing into larger funds and with mega tech buyout fund managers launching and scaling strategies targeting opportunities downstream from those targeted by flagship strategies – these include Francisco Partners’ Agility strategy, Thoma Bravo’s Explore strategy, and Vista Equity’s Endeavor strategy.

In particular, the small-cap tech segment (<$1B in fund size) continues to grow and diversify, filling a gap in the lower-middle market. This is evidenced by the growing number of spin-offs from larger firms wherein skilled investors with proven track records form their own firms to take advantage of relatively inefficient segments of the tech buyout market. Examples include firms like Banneker Partners (formed by ex-Vista Equity Partners co-founder Stephen Davis) and Luminate Capital Partners (formed by ex-Silver Lake investor Hollie Haynes). Banneker and Luminate are among the class of managers taking advantage of the growing opportunity in the small-cap segment of the market. Other members include Resurgens Technology Partners formed by ex-AKKR and H.I.G. investors, Equality Asset Management formed by ex-Summit Partners executives, True Wind Capital formed by ex-KKR investors, and TELEO Capital formed by ex-Marlin investors.

How are “Small Buyouts” Differentiated?

When it Comes to Entry Valuations, Size Really Does Matter

Small-cap tech buyout funds seek exposure to compelling, lower-middle-market software and tech-enabled services companies. Often these companies generate $10-$50M of revenue, are growing, and are at break-even or profitable. There are an estimated 85K software and software-enabled services companies generating less than $50M of revenue6.

With limited private equity capital chasing this massive market opportunity, less competition creates notable valuation advantages, allowing small-cap managers to access deals at much more attractive entry values vs. their larger peers. When looking at the median software and services multiples over the past 15 years, there is a remarkable 5.4x turn delta between the small-cap deals ($50-$200M equity investments) and the mega-fund deals ($1B+ equity investments).

Growth Levers: Mighty Things from Small Beginnings

As we explored in depth in our earlier article “Private Equity Appetite for Venture Buyouts: A Look at Value Creation Post-VC,” small buyout funds can take advantage of market inefficiencies that can translate into strong returns. These inefficiencies allow small buyout managers to not only buy companies for attractive valuations but also pull on several different growth levers during the investment period including operational improvements and accretive add-ons that help them scale meaningfully and benefit from multiple expansion. An array of well-funded and acquisitive buyers at the larger end of the buyout market provides healthy exit pathways that creates the potential for strong returns.

Exits: Buy Low and Sell High

As these smaller companies gain scale through organic and inorganic growth, their business and financial profiles become more attractive to larger strategic buyers and financial sponsors, often leading to competitive exit processes.

Increasingly, the buyer in such a transaction is another PE fund (a sponsor-to-sponsor transaction); such transactions accounted for approximately 49%1 of all PE exits from 2019 to 2022. In 2022 alone, sponsor-to-sponsor transactions accounted for 51%1 of all PE exits, the highest percentage on record, especially as other exit pathways slowed to a halt.

These smaller companies can be attractive to upstream buyout funds as new standalone platforms, or as add-ons to existing platforms, as larger buyout firms execute on their own buy-and-build strategies to scale their existing platform investments or to create synergies that can reduce costs or add revenue. In 2022, the number of add-ons as a share of buyout deals reached a record high of 78%1.

There is a broad appeal to these smaller companies as they reach scale, and with significant capital chasing fewer scaled opportunities, these companies are often exiting through highly competitive processes, furthering returns in the small-cap tech market. This is exhibited in the chart below where top quartile managers in the small end of the market are generating the best MOICs on transactions compared to their larger peers.

Another important yet often overlooked dynamic in today’s market is the use of debt. Over the past decade, mid-market and mega-buyout funds benefited from inexpensive financing. However, we expect this benefit to diminish significantly in light of the Federal Reserve beginning one of the fastest tightening cycles in more than 40 years8. In 2021, US loan volume set a 14-year8 high for backing LBO deals at $146B8. However, in 2H 2022, there was only $13.2B8 in US LBO-related volume (down 80.2%8 YoY). Not only is deal volume slowing, but portions of the cash flow from these larger businesses will no longer be used to fuel growth but rather will be diverted to service growing cash interest expenses.

Conversely, use of leverage in the small-cap tech market is limited, if used at all. This has allowed many of these software companies to remain nimble, with cash flow still feeding growth. Consequently, we believe this factor will continue to drive the outperformance spread between the large and small ends of the market.

“Small Buyouts” – Potential for Outsized Outcomes?

Over the last decade, we have seen an increase in investor appetite for small-cap software and technology companies. This shift presents an opportunity for emerging managers to come in at the early stages of the company’s lifecycle, and then scale them into prime buyout candidates for mid-market and mega funds.

As Wayne Gretzky once famously said, “I skate to where the puck is going, not where it has been.” As investors, it is critical to constantly reassess these dynamic markets look towards the future to produce repeatable and consistent returns.

We believe that small tech buyout funds are the best kept secret in private equity and will produce outsized returns for investors. This outperformance is driven by several key dynamics, including 1) lower entry valuations, 2) attractive inorganic and organic growth potential during the hold period and 3) efficient and well-capitalized exit markets. As a result, top quartile managers in the small end of the market have generated the highest MOICs of nearly 4x7 on transactions compared to their larger peers, ranging from 2x7 to 3x7 MOIC. In Part II, Industry Ventures will discuss the importance of the small buyout manager selection process and the ability to gain access to top quartile performance in small tech buyouts.


  1. Pitchbook: 2022 Annual Pitchbook US PE Breakdown Summary.
  2. Bain & Company: Global Private Equity Report.
  3. Pitchbook: Q3 2022 US PE Breakdown.
  4. Preqin, True Wind Capital, and press releases.
  5. Pitchbook Data as of March 31, 2022.
  6. Gartner and Vista Equity estimates.
  7. DealEdge Data from 2007 – December 31, 2022.
  8. Pitchbook: Q4 2022 PitchBook Analyst Note 2023 US Private Equity Outlook.

The views set forth herein are solely those of the author and do not necessarily reflect the views of Industry Ventures. The information and views expressed are generic in nature, and is not an offer to sell or the solicitation of an offer to purchase interests in any investments or services. Certain information contained in this article may constitute “forward-looking statements.” Any projections or other estimates contained herein, including estimates of returns or performance, are “forward looking statements” and are based upon certain assumptions that may change. Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking statements. There can be no assurance that the forward-looking statements made herein will prove to be accurate, and issuance of such forward-looking statements should not be regarded as a representation by Industry Ventures, or any other person, that the objective and plans of Industry Ventures will be achieved. All forward-looking statements made herein are based on information presently available to the management of Industry Ventures and Industry Ventures does not undertake to update any forward-looking statement that may be made from time to time by or on behalf of Industry Ventures.

This material does not constitute financial, investment, tax or legal advice (or an offer of such advisory services) and should not be viewed as advice or recommendations (or an offer of advisory services).

Certain information contained in this article (including certain forward-looking statements and information) has been obtained from published sources and/or prepared by other parties, which in certain cases has not been updated through the date hereof. While such sources are believed to be reliable, neither Industry Ventures and any general partner affiliated with Industry Ventures or any of its respective directors, officers, employees, partners, members, shareholders, or their affiliates, or any other person, assumes any responsibility for the accuracy or completeness of such information.