Why Invest in Middle Market Private Equity for Long-Term Growth

Investing in middle market private equity can be a savvy move for those looking to achieve long-term growth. Middle market companies, defined as those with revenues between $10 million and $1 billion, offer a unique blend of stability and potential for expansion.

These businesses often have a solid track record of performance, with 75% of middle market companies experiencing revenue growth over the past five years. This stability provides a foundation for investors to build upon.

One key advantage of middle market private equity is its ability to generate strong returns. According to a recent study, middle market private equity investments have delivered a median IRR of 20% over the past decade. This is significantly higher than the median IRR of 12% for large-cap private equity investments.

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Middle market private equity refers to investments in companies that are too large to be considered small businesses but not quite large enough to be classified as big enterprises. These companies typically have average deal sizes between $50 and $500 million, with some sources expanding this range to $25 million to $1 billion.

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Middle market private equity firms tend to focus on growth and operational improvements, using leverage in deals but also seeking returns from sources beyond simple leverage. They often acquire companies that are relatively local, such as in the Midwest of the U.S.

Middle market private equity firms have a relatively local focus, with most deals and portfolio companies located within a specific geographic area. For example, a middle market firm in Chicago is likely to focus on deals in the Midwest.

The average deal size for middle market private equity firms is around $300 million, funded with 50% debt and 50% equity. This suggests that the average middle-market fund should have capital in the low billions, such as $1-3 billion.

Middle market private equity firms tend to invest in more private and family-owned businesses, as there are more companies in these categories below a deal size of $500 million. They also tend to operate in 1-2 areas, such as private equity and credit, but rarely across multiple asset classes.

Here are some key characteristics of middle market private equity firms:

Middle market private equity firms typically focus on investments in the $50 million to $500 million range, with a holding period of 3-7 years. They often target companies with a strong management team in place.

These firms usually have a more flexible investment approach than larger private equity firms, allowing them to be more adaptable to changing market conditions.

Middle market private equity firms often have a strong network of industry relationships and a deep understanding of the middle market, which enables them to identify and capitalize on investment opportunities.

Investors in middle market private equity firms typically include high net worth individuals, family offices, and institutional investors such as pension funds and endowments.

Middle market private equity firms often prioritize preserving the company's culture and management team, as well as supporting their growth and development, in order to maintain the company's long-term success.

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Some of the top middle market private equity firms in the US include Audax, Genstar, American Securities, Madison Dearborn Partners, and Court Square, among others.

These firms have a significant presence in the middle market, with a focus on investing in companies that are often overlooked by larger private equity firms.

Examples of other firms that could be considered for this list are Friedman Fleischer & Lowe, HGGC, Stone Point Capital, and New Mountain Capital.

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When considering a career in middle market private equity, it's essential to understand the differences between upper and lower middle market firms.

Upper middle market firms (UMM) typically operate with a deal size of $500 million to $1 billion, with some European firms having a lower threshold of €250 – €500 million.

These firms often have more formal recruiting processes, including timed modeling tests and early start dates.

In contrast, lower middle market firms (LMM) usually have a deal size of $25 to $100 million.

Here's a summary of the different market categories:

UMM firms may also have longer work hours and more bureaucratic advancement processes, similar to larger private equity firms.

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Audax is one of the middle market private equity firms in the U.S. Genstar and American Securities are also included in this category.

In the U.S., Madison Dearborn Partners (MDP), Court Square, Friedman Fleischer & Lowe (FFL), HGGC, Stone Point Capital, and New Mountain Capital are all middle market private equity firms.

HIG, MidOcean, Lindsay Goldberg, Aurora Capital, Brentwood Associates, GTCR, Abry Partners, CI Capital, Aquiline, Riverside, and Vector Capital are also notable middle market private equity firms.

KKR and Blackstone, while considered mega-funds, do participate in smaller deals, which is why you'll see them in deal activity rankings.

Canadian pension funds, sovereign wealth funds, and other institutions also participate in the middle market, but they are considered separate from these dedicated firms.

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Working in Middle Market Private Equity is a great option for those looking for a balance between responsibility and work-life balance.

You'll have more autonomy and less hierarchy, giving you the freedom to think critically about deals and take on more responsibility. Average work hours are around 60-70 hours per week, which is less than what you'd find at larger PE firms or investment banks.

One of the biggest advantages of working in MM PE is the potential for higher returns, although this can be a bit of a contentious issue. At the senior levels, you may see higher returns, but it's not a deciding factor for most people.

You'll also have a higher chance of winning offers at MM PE firms if you've worked at a middle market bank, an industry-specific boutique, or a smaller group at a larger firm. This is because MM PE firms tend to value relevant experience over everything else.

Working in middle market private equity can be a great career choice, and here's why. You'll have more autonomy and responsibility on deals, with less hierarchy to navigate. This means you'll get to think critically and make decisions that impact the company.

One of the biggest advantages of working in middle market private equity is the work-life balance. You'll work less than you would at an EB/BB bank or a large PE firm, with an average week of 60-70 hours. This can be a welcome relief for those who value their free time.

Advancement opportunities are also more accessible in middle market private equity. With fewer people vying for top spots, you'll have a better chance of moving up the ranks. Plus, you'll get to work on a variety of deals and projects, which can help you develop a broad range of skills.

If you've worked in a middle market bank, industry-specific boutique, or even a smaller group at a BB/EB firm, you'll have a higher chance of winning offers at middle market PE firms. This can be a great way to leverage your existing experience and network.

If you're considering a job at a middle market private equity firm, you'll want to weigh the pros and cons. Compensation is a major factor – you can expect to earn 20-50% less than at larger firms.

One thing to keep in mind is the reputation of middle market firms. They're less well-known than mega-funds, which can make it harder to move within the finance industry. However, outside of finance, all private equity firms have relatively low brand recognition compared to banks.

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You'll also want to think about the types of deals you'll work on. Middle market firms typically handle simpler deal structures, which can be a plus if you're not a fan of complex financial modeling. But you may not have as many opportunities to gain experience with deal execution.

Here's a rough idea of the deal size ranges for middle market firms:

Keep in mind that these numbers can vary by region, and some firms may have different criteria for categorizing themselves.

Working in middle market private equity can be a fast-paced and dynamic experience. You'll likely spend more time on deals and portfolio companies compared to smaller firms with $500 million or less under management.

In a typical day, I find myself focused on process and deal-sourcing work, which is a significant departure from the pure Excel and financial analysis I'd do in larger firms.

Deals and portfolio companies take center stage in my work, requiring a lot of attention and effort. The smaller firm comparison shows that's a key difference in our line of work.

More process and deal-sourcing work means less time is spent on tasks that keep the firm running, like administrative duties.

Middle market private equity offers numerous benefits and opportunities for investors. Historically, middle market firms have been better positioned to adapt swiftly to market changes, capitalize on niche opportunities, and drive value creation through operational enhancements.

One key advantage of middle market private equity is its high potential for returns. Due to their growth potential and operational efficiency, middle market companies can yield higher returns on investment (ROI). This is evident in the fact that upper-quartile middle market funds have posted net internal rates of return (IRRs) that were 719 basis points higher than upper-quartile large-cap funds over the past 10 years.

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Middle market companies also offer significant opportunities for operational improvements. Private equity firms can leverage these opportunities to implement technologies, streamline operations, and expand into new markets, driving value creation.

Investing in middle market private equity can provide a high degree of portfolio diversification. Smaller deal sizes allow private equity firms to spread their investments across multiple companies, mitigating risk and enhancing portfolio performance.

Active management is also a key benefit of middle market private equity. Private equity firms often hire operating partners to advise their portfolio companies, and sometimes, these partners step in to take on full-time operational roles within the business.

Here are some key benefits of investing in middle market private equity:

Lower valuations and standard deviation are also benefits of middle market private equity. Valuations for global acquisitions of companies with enterprise values of US$1 billion or less averaged 36% lower than for larger companies over the past five years.

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Middle market private equity has shown strong performance over the years, outperforming large-cap buyout funds with a vintage of 2013-2021, according to the Preqin database.

This is evident in the net IRR (internal rate of return) data, where middle market funds have consistently delivered higher returns, with the 75th percentile IRR being significantly higher than that of large-cap buyouts.

Middle market buyouts have historically demonstrated lower correlation with the MSCI World public equity market index, which means they're less affected by market fluctuations.

A Preqin article supports this perspective, noting that mid-market deal activity has shown lower volatility and greater resilience compared to larger deals amid economic uncertainty.

The market share of US private equity middle market deals increased from 45% of total private equity volume in 2021 to 53% in 2023, reflecting the growing quality of middle market companies in the US.

This trend suggests that middle market private equity is becoming an increasingly attractive investment option for investors.

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Middle market private equity firms are divided into segments based on the size of the businesses they target. These segments include Lower Middle Market (LMM), Middle Market (MM), Upper Middle Market (UMM), and Large Cap.

The process of investing in middle market companies involves several critical steps, including deal sourcing and due diligence, valuation, and deal structuring. Juniper Landscaping was a platform investment made in January 2022.

Here are the market segments and criteria for private equity firms:

The investment process in middle market private equity involves several critical steps. Deal sourcing and due diligence are crucial to assess the financial health and operational efficiency of target companies.

Juniper Landscaping was a platform investment made by Graham Partners in January 2022, and it's a great example of this process in action. Graham Partners has a strong track record, with 4 fund strategies and a founding date of 1986.

To determine the value of a middle market company, valuation is a complex analysis that often involves comparable company analysis (CCA) to gauge market value. This process is essential to ensure that the investment is made at a fair price.

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Once a potential investment is identified, deal structuring is the next step, which includes terms like purchase price, equity shares, and ownership transfers. This is where the investment professionals, like the 10 at Graham Partners, come in to ensure that the deal is structured to meet the needs of all parties involved.

Here are the key steps in the investment process:

Each of these steps requires careful consideration and analysis to ensure that the investment is made in a middle market company that has high potential for returns.

When evaluating potential investments, private equity firms consider several key criteria. These criteria help them determine which businesses to target and invest in.

Company value is a critical factor, with private equity firms typically targeting businesses with values ranging from $10 million to over $5 billion.

The size of a business is also important, with firms dividing the market into segments based on company value and EBITDA (earnings before interest, taxes, depreciation, and amortization).

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Here's a breakdown of the different market segments and their corresponding company value and EBITDA ranges:

These segments help investors focus on specific areas and tailor their investment strategies accordingly.