Private Equity firms raised $122bn across 174 funds in 2017 for middle market transaction.
US middle market, the nation’s economic engine
"A deep pool of growing businesses"
Fertile investment territory. The middle (and smaller) market where company valuations top out at $1bn, provides one of the best ecosystems for private equity investors to create returns. The middle market offers more companies to invest in, greater opportunities to change the way companies operate, lower valuations and barriers to entry.
A collective GDP bigger than Germany. Private equity firms investing in the middle markets in the US are attracted by the increased number of opportunities provided by this market segment. There are about 350,000 private companies with annual revenues between $5m and $100m, compared with 25,000 companies with revenue between $100m and $500m and only a few thousand companies with revenue above $500 million, according to Forbes. This US middle market segment has a collective GDP bigger than Germany. In comparison, the number of US public companies today is around 4,330.
Making more of an impact: Many private equity managers have a sector specialisation in which they invest, such as manufactures of engineered products, consumer healthcare or financial services. The managers create value through operational improvements in these smaller growing companies. Executing such strategies in larger companies can be more challenging. The lower end of the corporate market gives a private equity firm the chance to make the necessary operational changes to drive a company’s growth.
Record activity in deals, capital raised & distributed
"Asset prices have risen, both private and public"
Investors continue to support the US middle market and private equity in general. US middle market private equity funds have enjoyed another excellent year of capital raising in 2017. Capital raising for the private equity sector in general has grown in recent years due to its’ long-term outperformance of most other asset classes as well as the positive net cash-flows (distributions minus contributions) to investors every year since 2012. This capital (returned in record amounts in the last two years) is being recycled back into those successful private equity managers.
US middle market not immune to rising valuations. Median middle market M&A EBITDA multiples have risen to all-time highs (10.7x EV/EBITDA through Q3 2017), largely as a result of stronger deal activity in the upper middle-market segment and the increase in capital available to invest thanks to the virtuous circle of record capital raising and distribution activity. This contrasts with the Russell 3000 which has an EV/EBITDA of 13.4x (source: Bloomberg, 03/2018). Private assets are still cheaper than public.
Lenders have loosened the purse-strings: The credit market for US middle market acquisition activity is robust and functioning well, creating pressure to deploy capital by lenders. This has led to an increase in ‘covenant-lite’ agreements (where the lender is stripped of certain protections) and debt to EBITDA on company balance sheets, increase for the sector as a whole.
Sources: SGPB, Preqin and BCG Nov 2017, 04/04/2018. Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invest.