How do returns change with fund size?

As European private equity evolves, fund size increasingly shapes how funds deploy capital and tap into market opportunities. Larger funds, with their ample reserves, often target companies in the upper segments of the market with limited growth potential and buy them through competitive processes with multiple bidders. Meanwhile, smaller funds focus on acquiring small companies with potential for professionalisation that compose a major part of Europe’s economy but are often overlooked by investors. In this article, we examine how fund size influences expected returns by comparing performance trends across funds of varying sizes.

In the European market, returns tend to decrease as fund size increases. Our analysis shows that, on average, lower mid-market buyouts tend to be the best performers in the private equity space with a 20% net IRR. In contrast, mid-market buyouts average a 16% net IRR whilst both large and mega buyouts average a 15% net IRR. Hence, the private equity lower mid-market has 4-5 bps higher return than the upper segments of the market.

This difference in average returns occurs because lower mid-market buyout funds tend to focus on a portion of the market that benefits from many favourable market dynamics.

In the European Union, Small and Medium Enterprises (SMEs) comprise 98% of all companies and employ two-thirds of the workforce. However, our analysis reveals that only 9% of European private equity capital is allocated to the lower mid-market segment. This segment, by contrast, represents 50% of the economy, creating a favourable supply-demand dynamic for GPs focused on this space. Such market conditions facilitate capital deployment potentially reducing management fees over the fund’s life as capital is put to work more efficiently.

Lower mid-market funds tend to focus on smaller-sized companies which offer greater potential for operational improvement compared to larger firms in the upper-market segment. For example, in Germany, the value added per employee is approximately €49k for companies with 20-249 employees, while for companies with over 250 employees, it increases to around €65k—a difference of c. 33% that can potentially be achieved through scaling, professionalisation and other operational enhancements. While this improvement potential varies by region, the trend is consistently evident across the European market, underscoring the substantial growth opportunities within the lower mid-market segment.

The clear supply-demand imbalance in the lower mid-market presents an opportunity for GPs to access more attractive valuations. Our analysis shows that valuation multiples increase as enterprise value rises, driven by the premiums paid in the upper market segments and the intense competition for these larger companies. In contrast, the lower mid-market remains comparatively undervalued: in 2021, transactions involving companies with an Enterprise Value (EV) under €25MM reflected a 25% discount in EV/EBITDA multiples compared to companies with an EV between €25MM and €250MM, and a 53% discount compared to those with an EV above €250MM. This trend is largely due to the highly competitive processes through which larger companies are acquired, often resulting in elevated multiples. However, smaller, specialized funds focused on the lower mid-market, can access niche opportunities where there is less competition, enabling more attractive entry multiples and greater potential for value creation.

Additionally, downside risk is reduced in lower mid-market transactions due to generally lower debt levels. For example, transactions involving companies with an EV below €200MM have, on average, an entry Net Debt (ND)/EBITDA ratio of 2.8x, which is 40% lower than those of transactions with an EV between €200MM and €500MM, and 55% lower than those with an EV above €500MM. This lower leverage gives GPs a natural hedge against bear markets, offering enhanced downside protection for their portfolios.

The advantages of the lower mid-market relating to supply and demand imbalance, favourable entry multiples, and lower levels of company debt are evident when comparing transaction returns across companies of varying sizes. Our analysis indicates that average returns tend to decrease as transaction EV increases. Transactions with an EV of less than €15MM demonstrate the highest average returns, achieving a 3.8x gross MoC, whereas deals with an EV over €120MM yield the lowest average return at 2.5x gross MoC. Additionally, smaller deals exhibit stronger top-quartile and top 10% performance metrics, with comparable downside protection, underscoring a more favourable risk-return profile. For example, deals with an EV between €15-30MM achieve a minimum threshold of 6.5x gross MoC within the top 10%, with a top quartile performance of 4.2x and a bottom quartile return of 1.6x. In contrast, transactions with an EV exceeding €120MM have a top 10% performance of 4.4x gross MoC, a top quartile of 3.0x, and a bottom quartile of 1.6x. This suggests similar downside protection but with significantly higher upside potential in smaller deals. At the bottom 10%, deals in the €15-30MM range have a gross MoC of 0.2x, just slightly lower when compared to 0.4x for deals exceeding €120MM. Overall, European transactions with an EV below €45MM demonstrate superior returns when compared to larger investments.

Hence, we can conclude that smaller funds targeting companies in the lower mid-market, benefit from favourable supply and demand imbalance that enables efficient capital deployment and presents opportunities for operational improvements and professionalization. Additionally, this segment often provides more attractive entry valuations and reduced leverage risk compared to larger funds, all of which contribute to stronger return profiles. As such, fund size is a crucial factor in evaluating potential primary investments, as it significantly shapes both the deployment strategy and the risk-return profile of the fund.