Everything you need to know about Middle Market Private Equity

Everything you need to know about Middle Market Private Equity

Nov 02, 2023 | Editorial Team

The role of billion-dollar and global tech firms in the US economy is significant, but the large segment of mid-sized companies cannot be undermined. The middle market has attracted many private equity investors because it promises immense growth opportunities. Middle-market firms are highly fragmented and have more potential for operational augmentation. Being more flexible and adaptive, these firms innovate and capture the market. Middle markets have also stood strong in times of uncertainties, like the financial crisis of 2007-2009 in the US. At that time, middle market companies had provided 2 million jobs.

According to the 2022 Mid-Year Middle Market Indicator by the National Centre for the Middle Market, the annual revenue growth in the middle market has been 12.2%. Middle-market transactions include less leverage and lower valuation for acquisitions. This has made middle market private equity more attractive to investors. Its revenue growth and wide margin also lure private equity investors. No wonder middle-market companies are a considerable share of private equity deals!

What is Middle Market Private Equity?

Middle market private equity is a broad term. While it refers to the size of a private equity company fund, it may also include the amount of the raised capital, the size of the recent funds, the average deal size, etc. But the most common answer to ‘what is middle market private equity?’ is - the company’s having revenues between $10 million and $1 billion. At the same time, some define the middle market for private equity as firms with revenues between $25 million and $1 billion. Usually, large market private equity deals are $1 billion or more.

It is believed that there are two hundred thousand middle-market businesses in the US alone, where one-third of the US workforce is employed.

Upper vs. Lower Middle Market Private Equity Firms: The Difference

The private equity market can be categorized into different segments based on the size and scale of the companies they target. We can categorize the market into:

  • LMM: Lower Middle Market
  • UMM: Upper Middle Market
  • CMM: Core Middle Market

While Lower Middle Market has a deal size of $25 to $100 million, CMM has $100 to $500 million, and UMM has $500 million to $1 billion. These criteria may be particular to the US and differ in different regions. According to these sections, UMM firms are largely for mega deals. The private equity mega funds mean doing $1 billion+ deals and having individual funds of around $10 billion. The companies that may be included in this category are Carlyle, Apollo, Blackstone, Warburg Pincus, Advent, etc.

The deal size and capital bases are not the only difference between Upper and Lower Middle Market Private Equity Firms. UMM is different than LMM in the following aspects:

  • Since Upper Middle Market Private Equity Firms funds are highly diversified and are active across all regions and classes like credit, infrastructure, etc., they may not focus much on private equity.
  • UMM deals mean heavy leverage and capital structure and offer limited growth opportunities.
  • UMM recruitment is a fast, stressful, and on-cycle process. It would help if you were from the top groups to have your chance.
  • Career advancement might be sluggish, and you might take a lot of time to move up, as numerous people are in the mid to top hierarchy.

Middle Market Strategies and Relevance

The middle-market companies are less mature and offer more scope for new private equity investors. Big companies provide less scope to increase earnings through operational enhancement. Middle-market companies have a huge inorganic growth opportunity. Private equity firms help with capital, market consolidation, and helpful strategies.

During economic turbulence, it is wise to invest in the middle market. According to Mergermarket and White & Case data for 2022, while the large-cap deals dropped by 40% in volume, the middle market only fell by 19% for the same period. The middle market offers more consistent deals in uncertain times, while large markets are limited. In the current market scenario, the investors are strategizing on middle-market deals and finding them more attractive.

The current and the most common strategy of middle market PE today is – “Add-on” deals. By Q3 2022, 72% of all PE middle-market buyouts were “Add-on” deals. An add-on acquisition means buying a smaller company and integrating the same into the existing company. This grows the parent company in value. This buy-and-build strategy strengthens the company’s value, capabilities, market share, and revenue.

Middle-Market in Private Equity: The Advantages

Middle-Market in Private Equity

There are numerous reasons why the middle market has attracted investors:

  • Leverage: The middle market is less reliant on leverage. Since last year, the availability of acquisition finance has been low, posing a challenge for private equity investors. Due to this, the large investors relying on financial engineering got a setback. This strategy can work when the investors hope the price increases in the bull market, where the credit is low-priced and abundant. When the interest rate is high, it becomes hard to deliver. Mid-market companies use less leverage and can be bridged with equity. Also, it does not create more individual assets for the sponsors.
  • Low Entry Valuation: Middle market companies have always meant lower entry multiples. The large deals funding has become increasingly rare and expensive. The smaller deals in the middle market space have gained more momentum. The investment firms prioritize lower valuations to go ahead with the higher equity transactions.
  • Wide Exit Windows: Strategic buyers do not invest in big-ticket M&A, especially during uncertainty. Large-cap investors have to wait for the exit route to open during these periods. In the mid-market, there are exit routes. This is why trade buyers are more comfortable buying smaller businesses. This way, they protect their balance sheet, sell their private equity to bigger managers, and close secondary buyouts.

The Last Words

Private equity firms know the innumerable growth opportunities in the middle market. These investors are also entering the mid-market segment to experience innovative developments, scale their work, and improve their outcomes. The private equity acquirers are rolling up their sleeves and moving to the middle market, aiming for long-term growth. They believe that operation improvement, better opportunities, and successful exit are better models for creating value.

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