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Comparing Lower Middle Market Private Equity Performance by Value Creation Approach

Key Takeaways

• McKinsey found that GPs focused on operational value creation achieved IRRs 2–3 percentage points higher than peers across 100+ funds with post-2020 vintages
• KPMG's 2025 survey found that 64% of PE firms now rank margin growth as their top value driver, a decisive shift from financial engineering
• Morgan Stanley analysis of 166 U.S. transactions found that middle market managers grew revenue and EBITDA by nearly 3x the amount of large-cap peers
• Operational improvement is most concentrated in the lower middle market, where companies have the widest gap between current operations and best practice

Private equity value creation strategies are not created equally, even when the headline IRR looks the same. Two funds can post the same net return, yet one gets there through repeatable EBITDA improvement while the other benefits from a one-time tailwind like multiple expansion. Recent research points to a clear shift: as rates rose and exits slowed, firms leaning on operational change have tended to hold up better than those relying on leverage or valuation lift.

That dynamic is especially pronounced in the lower middle market, where many companies still have meaningful operational and technology gaps. This article summarizes what major datasets converge on, breaks down the three core value-creation levers, and outlines the diligence questions LPs can use to evaluate whether a GP's process is real — or cycle-dependent.

The distinction has become a first-order concern for LPs. McKinsey's analysis of more than 100 PE funds with post-2020 vintages found that GPs focused on operational value creation achieved IRRs two to three percentage points higher, on average, than peers.

KPMG's 2025 Global PE Value Creation Survey, covering 500 respondents across firm sizes and geographies, found that 64% of private equity firms now rank margin growth as their top value driver, a decisive shift from an era when financial engineering and multiple arbitrage dominated the playbook. For investors evaluating fund managers, understanding how a GP creates value — not just how much value is created — separates durable outperformance from returns that evaporate when the cycle turns.

What the Research Agrees On: Operational Value Creation

No single dataset captures the full picture of private equity value creation strategies, but the best-cited institutional research converges on a consistent takeaway: repeatable operational improvement shows up as the most reliable driver of outcomes, while multiple expansion is more cycle-dependent.

The pattern across these datasets is consistent: the PE industry leaned disproportionately on multiple expansion and leverage through the 2010s, and those tailwinds have reversed. McKinsey's 2025 Global Private Markets Report described the shift plainly: dealmakers and operators are moving from traditional financial engineering to sustained operational transformation.

The Three Levers of Private Equity Value Creation

Private equity returns are split into three primary drivers: operational improvement, multiple expansion, and financial engineering. Every buyout combines these levers in different proportions, and the mix reveals a great deal about both the durability of returns and the GP's actual capability.

Bain's 2025 Global PE Report illustrated the limits of the prior regime with a sector-specific lens: over the past decade, revenue growth drove 52% of value creation in software buyout returns while multiple expansion accounted for 42%, but margin improvement contributed almost nothing. Relying on that formula in a tighter environment poses real risk, and firms that cannot deliver margin expansion alongside revenue growth face a structural disadvantage.

Why Operational Value Creation Dominates in the Lower Middle Market

Lower middle market companies — businesses with $1 million to $25 million in EBITDA — are structurally different from the institutional-grade assets that populate mid-market and large-cap portfolios. Most are founder-operated. Many have never had a CFO, an ERP system, or a formal sales process. Customer relationships live in the owner's head, not in a CRM.

These characteristics are typically perceived as risk factors, and they are. But they also contain concentrated operational upside. A business running on outdated workflows, manual inventory management, and undocumented pricing has substantial room for improvement before a GP even considers inorganic growth.

A 2023 Morgan Stanley analysis found that middle market PE transactions derive a higher percentage of value creation through organic growth — improving earnings, growing margins, and expanding product lines — compared to large-cap funds, which rely more on leverage and multiple expansion. The analysis of 166 U.S. transactions found that middle market managers grew revenue and EBITDA by nearly triple the amount of their larger-cap peers from purchase to exit, generating higher realized capital multiples (3.75x vs. 3.2x for large-cap buyouts).

The structural reason is straightforward: lower middle market companies are less efficiently run, so the marginal return on operational intervention is higher. A $5 million EBITDA manufacturer that has never optimized its pricing, never implemented demand forecasting, and never formalized its sales pipeline has dozens of available improvement levers. A $500 million EBITDA business acquired by a large-cap fund has likely already been through one or two PE ownership cycles and had those levers pulled.

The Value of Technology-Enabled Private Equity

Technology adoption has become the sharpest operational lever in lower middle market private equity, particularly in manufacturing, distribution, and services businesses where digital infrastructure is not as established.

The opportunity is large because the starting point is low. Many lower middle market companies still operate on legacy systems or no systems at all. Inventory tracked in spreadsheets. Customer orders taken by phone and entered manually. Financial close processes that take weeks instead of days.

Consider a $5 million EBITDA distribution company with 40 employees, no integrated order management system, and manual route scheduling. Implementing a modern ERP with automated order-to-cash workflows can reduce days sales outstanding, cut fulfillment errors, and free operational staff time — each contributing directly to margin expansion without incremental revenue. Layer on demand forecasting and dynamic pricing, and the same business generates more profit from the same customer base.

Technology improvements professionalize the business in ways that improve the exit narrative. A company that demonstrates integrated financial reporting, automated operations, and data-driven decision-making commands a higher exit multiple than the same business running on manual processes. The operational improvement and the multiple expansion become linked, creating a flywheel that depends less on broader market conditions.

The Quant Private Equity House

That is the post-acquisition value creation story. Upstream, the evaluation of lower middle market firms is increasingly using data and automation to assess targets faster and with more precision.

Private equity operations teams are increasingly deploying tools like agentic AI, retrieval-augmented generation, and advanced data pipelines during diligence itself, not just post-acquisition.

A 2025 KPMG survey found that 70% of private equity firms planned to increase their investment in operational AI by up to 25% or more. Yet operational value creation employees represent just 10% of headcount across the top 10 PE firms, compared to 56% in investment roles — a ratio that KPMG noted needs to roughly triple.

Firms that can deploy engineers, data scientists, and systems architects alongside their deal teams hold a structural advantage. The trend toward what KPMG has called the "quant PE house" — firms applying quantitative and technology-native approaches to portfolio management — is most pronounced and most impactful at the lower middle market level, where the gap between current operations and best practice is widest.

How Should LPs Evaluate Fund Managers on Value Creation?

LPs should evaluate fund managers on value creation by asking a simple question: where did the returns actually come from — EBITDA improvement, leverage, or multiple expansion? A track record built mainly on multiple expansion is largely a bet on market tailwinds; a track record built on EBITDA growth is evidence of a repeatable operating process that can travel across cycles.

Bain's 2025 midyear report captured the current dynamic: with exit timelines lengthening, GPs need to refresh or extend their value creation plans to convince buyers that new chapters of growth remain, and the evidence of EBITDA growth needs to be real progress, not a pro forma aspiration.

The following questions cut through to reveal actual capability:

• What percentage of historical returns came from EBITDA growth vs. multiple expansion vs. leverage? A GP that cannot disaggregate returns by driver either does not track the data or does not want to share it. Both are red flags. The best managers publish value creation waterfalls in their investor letters.
• What does the operating team look like, and what do they actually do? Many funds list an "operating partner" or "value creation team" in their pitch decks. The question is whether those individuals are full-time, what their backgrounds are, and whether they spend time on-site at portfolio companies.
• What is the hold period, and why? Shorter hold periods can mask weak operational improvement: a GP that buys at 6x, adds no value, and sells at 8x during a period of broad multiple expansion has not created operational alpha. Funds that commit to longer hold periods signal confidence that their value creation plan can compound over time.
• Can the GP point to specific operational changes and their measured impact? The most credible evidence of value creation is granular. "We implemented automated scheduling at Company X, which reduced labor costs by 14% in the first year" is more informative than "we grew EBITDA by 30% during our ownership period."

Jamestown Capital's Approach to Operational Value Creation

Jamestown Capital was founded by quantitative traders, and a quantitative approach determines how the firm underwrites deals, evaluates operations, and deploys resources post-acquisition.

We target lower middle market businesses in manufacturing, distribution, and suppliers for safety and compliance, infrastructure, or health care — sectors where operational complexity is high but technology adoption is often low. The firm's investment thesis centers on a specific hypothesis: that applying modern data infrastructure, automation, and process engineering to under-professionalized businesses generates durable EBITDA growth that is independent of macroeconomic conditions.

We have built a proprietary Leveraged Buyout (LBO) engine in the Rust programming language that is accurate to the penny. The modeling challenge, as we have covered in our research on realistic LBO models, is not the math but the inputs. To ground those inputs in reality, Jamestown uses public equity data, SBA loan performance data, and analytical tools to stress-test projections before committing capital. Our SBA lender and business valuation tools are publicly available.

Post-acquisition, Jamestown deploys its technology team directly into portfolio companies. Co-founders Henry Carter and Nate Harner work on-site during systems implementation periods, spending consecutive days migrating data, restructuring workflows, integrating software platforms, and building custom automation.

Jamestown commits approximately 10% of fund capital as GP investment — roughly five times the industry standard. The firm targets a 30% projected IRR with a minimum five-year hold period. Its conviction is that operational value creation — executed with technical depth and measured rigorously — produces returns that are both higher and more durable than those generated by leverage or market timing.

For LPs evaluating lower middle market fund managers on the basis of value creation approach, Jamestown's research hub provides additional context on analytical methodology.

Operational Improvement Drives Lower Middle Market Value

The data reviewed here converge on a consistent finding: operational improvement is the most durable driver of private equity returns, and it is most concentrated in the lower middle market. Multiple expansion and leverage amplified returns through the 2010s, but those conditions have largely reversed.

Funds that cannot demonstrate concrete EBITDA growth — measured, specific, and tied to identifiable operational changes — face mounting pressure to justify their track records.

A value creation story built only on favorable exit conditions is not a repeatable process. One built on pricing discipline, technology implementation, and process improvement at the portfolio company level can be. The firms positioned to outperform the next cycle are those that built their operating capabilities before the cycle turned.

The lower middle market remains the part of private equity where that gap between current operations and best practice is widest — and where the return on operational intervention, executed with technical depth, is correspondingly highest.