Middle-market companies account for one-third of US GDP. Middle-market companies account for the majority of private equity deals. This blog will explore what middle market private equity is, examine why it is attractive to private equity, and discuss how this space responds to the current market dynamics.
What is the Middle Market?
Data providers and managers will classify the middle-market private equity space differently. Private equity mid-market companies typically have an enterprise value (EV) sweet spot between $50 million and $500 million. These ranges may start at $5 million but sometimes reach $1 billion.
Visma was the first business software company to be backed by private equity. In 2006, Hg invested PS101 million to take the Group private. At the time, the value of the Business was PS382million. Since then, Visma has made hundreds of bolt-on acquisitions. It has grown EBITDA with a compound annual growth rate of 23%2 and, by the end of 2021, achieved a valuation of $19 billion. The headlines are often dominated by mega-buyouts worth billions of dollars, but the best deals and the highest returns can be found in lower-profile mid-market transactions.
Why is the Mid-Market Vital in Private Equity?
The mid-market in private equity refers to companies that fall in the middle range in revenue, typically ranging from tens of millions to a few billion dollars. The mid-market is a crucial segment for several reasons, and private equity firms often target investments in this space for various strategic advantages. Here are some reasons why the mid-market matters in private equity:
1. Low Entry Prices, Increased Willingness to Bargain
After M&A valuations reached record levels in 2021, buyers have become more sensitive to pricing and are careful not to overpay for companies at entry. In the past, buyers have paid lower multiples to enter mid-market companies. PineBridge research shows that the average access multiple for companies with an EV less than $500m was 17% lower in the last five years than the numerous for more significant assets.
2. Fragmented Ownership
Mid-market companies are often more fragmented in ownership and have more private owners. Private equity firms consolidate ownership by hiring professional managers and implementing best practices to drive operational improvement.
3. Operational Improvements
The resources and expertise needed to improve operational efficiency may be lacking in mid-sized businesses. Private equity firms can bring in experienced managers and implement best practices for portfolio companies.
4. Exit Opportunities
Mid-market companies can offer a variety of exit strategies, including selling to strategic purchasers and private equity firms or conducting initial public offerings (IPOs). This flexibility attracts private equity investors seeking the best possible private equity exit strategies.
Private equity firms can diversify their portfolios by investing in the middle market. Diversification helps manage risk and can reduce the impact of economic recessions in specific sectors.
6. Growth Opportunity
Mid-market firms often have a significant growth potential. Private equity firms can leverage their management skills, expertise, and resources to help these mid-market companies expand, enter new markets, or enhance product/service offerings.
7. Attractive Reward
Private equity firms have a wide range of options in the mid-market, whereas large deals are more difficult to execute and find. Mid-sized investments can provide investors with attractive returns.
8. Lower Competition
Comparatively to the ample cap space, mid-market companies tend to face less competition from private equity firms, institutional investors, and strategic buyers. Private equity firms can benefit from greater negotiating power and better deal terms.
Private equity firms can diversify their portfolios by investing in the middle market private equity. Diversification helps manage risk and can reduce the impact of economic recessions in specific sectors.
10. Relationships With Management
Private equity firms often develop stronger relationships with management teams in the mid-market. This collaboration is crucial for successfully implementing strategies and changes to drive growth.
11. More Levers to Growth and More Excellent Room for Returns
This is mainly because investments in this sector have more potential to grow in terms of operational efficiency and scale. In terms of their business development, smaller and lower middle-market firms usually need to be more developed than larger cap targets. Private equity investors can use this opportunity to improve management teams, add new products, and enhance financial controls. Private equity firms can support mid-market consolidation and buy-and-build strategies with capital and M&A expertise.
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The mid-market is essential in private equity, as it offers various investment opportunities with attractive returns and significant growth potential. It also presents the opportunity for operational improvement. Private equity firms that target the mid-market can leverage their expertise to create value and make successful exits.