Why the Middle Market Matters – Now More Than Ever
The “middle market” is to the U.S. economy what North America was to Christopher Columbus: a giant, incredibly important, heretofore “undiscovered” but now unavoidable and centrally important part of the world’s landscape.
It’s a landscape I know exceptionally well from a 25-year business career spent in the heart of it. After a short stint as a business journalist, I moved on to become founder of two successful middle market companies. (One those, in turn, blossomed into one of the nation’s largest independent middle market investment banks, giving me a decade’s worth of experience inside the brains of middle market company founders and CEOs.)
More the realm of ambitious entrepreneurs and solid family business dynasties than boardroom-polished MBAs, middle market companies have stepped out into the light and are being recognized in aggregate as a huge and increasingly critical segment of the American—and global—economy.
Individually, these companies tend to be smaller, less visible and vastly less reported upon than their publicly-owned brethren, but their impact taken together—though historically hard to evaluate precisely—is large and growing larger in this era of economic restructuring and retrenchment.
WHAT’S A MIDDLE MARKET COMPANY?
It seems every website copywriter and every kind of company serving the middle market has its own definition for what the middle market is.
Practically speaking, middle market companies are bigger than "small businesses” but smaller than large global corporations. That leaves an awesome amount of definitional wiggle room, which is part of the reason it's hard to identify and quantify the exact size and impact of this enormous economic segment.
I’ve seen many generally reputable websites and reports that claim the middle market starts at revenue or valuation levels of $5 million, $10 million, $25 million, $50 million, and $100 million. At the upper end of the middle market neighborhood, I’ve seen those same sites claim revenue or valuation cut-offs of $100 million, $250 million, $1 billion, and $2 billion.
Needless to say, that’s a very, very broad range.
Clear as mud, right?
But if there’s no one certain definition of what a middle market company is, we can at least confidently say this: middle market companies are not mom-and-pop shops with six or seven employees and they’re not giant public companies with high profiles and flashy media-friendly CEOs. They’re more likely located in your city’s industrial park than on either Main Street or Wall Street, and they are spread across every state and city in the U.S.
They’re also invisible because the companies themselves often lack communications skills. It always seems to me that it takes a middle market company CEO two or three times as long to tell you what his or her business does than it would for a pizza parlor owner or a big-company executive to tell you about theirs. (That’s largely because what their companies do is often very specific and targeted and therefore happens several layers beneath most people’s general understanding of how the world works.)
AN INVISIBLE, POWERFUL ECONOMIC SEGMENT
In my experience, middle market companies are comprised of an astonishing range of low-profile businesses in every industry and in every part of the country. They perform vital tasks and develop and manufacture critical parts and technologies that drive our national and global economy. Figuratively speaking, I’d say middle market companies make the world go ‘round efficiently—and rarely get credit for it.
Middle market companies can employ from a few dozen to several thousand people, and their ownership is more often private than public. Since they often serve business-to-business markets with their products and services, the chances that you’ve “liked” a middle market company on Facebook or follow their Twitter feed are very low.
They are both young companies fueled by angel-provided capital and powerful technology engines and old-line family-owned craft-driven manufacturers making products that haven’t changed much over the last century. Their financial performance characteristics vary as widely as their growth rates, and their approach to human resource management stretches from warmly paternalistic to coldly Darwinistic.
Middle market company founders invest capital differently and manage their enterprises differently than their higher-profile public company and lavishly-funded venture capital counterparts. Their actions and strategies are both more personal and idiosyncratic as a result, and while quarterly earnings pressures aren’t generally part of their environments, tough capital markets loom even larger and more ominously in the middle market world.
Despite all these differences, middle market organizations are often hung on the same hook as Big Business when economic or political punching bags are needed. Regulations and laws that big companies with big lobbying staffs decide they can live with can cause material damage to middle market companies. (Although in some cases I suspect that’s exactly how Big Business likes it.)
THE VITAL HEART OF JOB GROWTH
Because middle market companies are not easily grouped and therefore not easily studied, their economic impact is not well understood. But one thing I can prove statistically is that the middle market does serve as a kind of incubator for big business. In the last five years, there have been an astonishing 11,783 acquisitions of middle market companies by strategic acquirers—larger companies, in the great majority of cases—with an astonishing $1.13 trillion of total deal value. (Source: Headwaters MB LLC.)
So we can say for certain that the growth and innovation these companies create contributes a shocking amount of value and dynamism to the U.S. economy.
But there’s more: Start-ups that succeed (and by definition bloom into middle market companies) have been responsible for nearly all net U.S. job growth since 1980, according to a recent study by the Kauffman Foundation. While not every middle market company is a current job creator, we do know that Fortune 500 companies shed more than 800,000 U.S. jobs in aggregate as recently as 2009, so looking to that group for an employment turnaround isn’t likely to be very productive.
Perhaps a middle market stimulus program should be a plank in some party’s 2012 platform.
A BIFURCATED CAPITAL MARKET
Middle market companies are the speedboats of our economy, in contrast to Fortune 500 companies that act more like battleships and aircraft carriers. Their smaller size of middle market companies means they can change direction faster, adapt more aggressively, innovate more nimbly, and potentially generate outsized returns to their investors.
Harder to raise capital
At the same time, their management ranks tend to be thinner, their access to capital vastly narrower, and their reliance on key customers greater, making their results more volatile and their economic footing generally less certain that larger companies.
The reality is that middle market capital markets are bifurcated from the markets you hear about and study every day on CNBC.com. The cheap debt and generally strong equity markets available to large public companies over the last two years remain a mirage to most middle market companies for several reasons. Since many are younger companies, their financial histories are much shorter and much less consistent and their lending relationships not nearly as well-established. The personal balance sheets of middle market company founders are often highly entwined with their company’s. And since most are privately held, liquidity for their investors is scarce and generally only widely available if the company is sold.
Raising equity is vastly more time-consuming for the management of middle market companies, and those without a major private equity firm among their investors are generally shut out of public debt markets. Bank financing is truly critical to the segment, and when the TARP era hit the US in 2008, no group of companies was pounded harder by bank lenders heading for the shelter of lower loan balances and better credit ratios.
That trillion dollar-plus M&A figure has occurred despite the nasty beating that middle market deals have taken. The value of transactions has dropped 50% from 2007 to 2009 according to statistics published by Dealogic. 2010 brought a slight recovery, but the dearth of debt for middle market buyouts and strategic acquisitions has pushed many players to the sidelines and kept them there.
That in turn has generated a significant drop in valuation metrics over the last five years, depressing returns for private equity funds and further crimping equity capital formation in the sector.
I believe the middle market is largely invisible in the business media because it’s an difficult sector on which to report. Its hard-to-define borders make it challenging for news outlets to decide what falls under middle market coverage and what doesn’t, and many M&A transactions are done by middle market companies who see little or no upside in public disclosure of their activities. When companies don’t issue press releases on deals they’ve done (especially not in real-time when the deal would actually qualify as news), news outlets with tight budgets can quickly turn their attention elsewhere.
In addition, many acquisitions of middle market companies by public companies are small enough that they never meet the standard of "materiality", and therefore are never reported by the acquiring public company. (That was actually the case in the acquisition of my first company by a go-go NASDAQ technology manufacturer.)
WORTH PAYING ATTENTION TO
Nonetheless, the great energy and inventiveness that has marked American business over the years remains highly evident in the world of middle market companies. The great middle market entrepreneurs and executives I know are continuing to globalize, technologize, and seek opportunity during this extended downturn. They are growing increasingly savvy about how business and markets are changing via the supercharging and scouring out of the Internet, and they are re-thinking and retooling the way they collaborate with employees and subcontractors for even greater efficiency.
No one lasso will easily rope in the whole middle market herd for you to understand and evaluate. But getting underneath America’s Big Business lid will surely reveal more to you about our collective economic future than will what happened today to the DJIA. And CNBC.com will help take you there.