Beneath the screeching Klaxon alarms, raised by frenetic media on all things related to deal making, lies a deep – and historically vibrant – Middle Market. Undaunted, intrepid reporters dash through press rooms clutching another article decrying companies “laden with debt”, “leverage limits”, “criticized assets” of the if-it-bleeds-it-leads meme – while a vast sector of the economy that drives real growth and real value hums along, all but ignored. But here is the problem. Although others have eloquently delineated the size and importance of the Middle Market, little has been made of the sector’s weight problem. Hard may it be to admit publicly, the time has come to vigorously address the issue.
While splashy features, books, and movies are made about dashing large cap deal makers, the Middle Market ecosystem resides in relative obscurity. Although billions of pixels have died showing fundraising, overhang, investment, leverage, etc. of the overall deal market – if we don’t confront the weight problem of the Middle Market, we’re highly at risk of making wildly inaccurate inferences from what we read, even in the business press.
PitchBook was one of the first and more complete analytic platforms to highlight the weight issue by explicitly showing deal volume weighted by capital invested and by number of deals (see above). Without this critical analysis, an unwitting observer might take attributes of one sector and infer, quite incorrectly, that they were more widespread than they were in reality. Let’s take an fun example: across 2011-2014, deals larger than $400 million made up 59.5% of capital invested – but contributed to less than 10% of the number of deals. So, if our well-meaning, but harried reporter – consumed by a deadline and a need to fill space – fails to grasp the weighting issue, we get (absurd) headlines such as:
“Signs of Conspiracy: Most Private Equity Investment Led
by a Steve, a Henry, or a David!”
Back on earth, 91% of deals are being done with deal valuations below $400 million – where Bill, Bob, John, and the gang are doing yeoman’s work out of the spotlight – first flight out Monday morning from the Southwest Airlines terminal with no G500 in sight. To put a finer point on this, 85% of deals are at or below $300 million and two-thirds of deals are done below a valuation of $100 million – that’s over 6 in 10 deals with $40 million or less in equity and $60 million or less in debt. The latter are very, very different animals from broadly syndicated, institutional debt deals.
Why does this matter?
Without getting arcane about statistical inference, if a non-representative sample is analyzed in a vacuum there is a host of problems in extrapolating descriptive statistics from the sample to the larger population. For example, if I grabbed the sports page and averaged some data there – I’d look a bit silly to say, based on that research, I believed the average person was 6’2”” and over 220 lbs. – and ran a 4.9 sec 40-yard dash!
As we will discuss in future notes, there are significant differences in deal methodology (structure, leverage, investment theses, sourcing, etc.) across deal sizes. This matters to investors, to operating companies, and to regulators.
Reasonable people want to accurately understand their market and the risks and rewards therein. So, be very careful when someone shouts “Well the market is…” or “The average deals is…” While the Middle Market can handle its weight problem, really poor investment decisions are made by poor analysis.