If you ask 10 managers to define the mid-market you will probably get 10 different answers.
The segment is hard to define partly because large investors have moved downstream where they are competing with dedicated mid-market players for deals of all sizes in high-growth sectors, says Rob Brown, CEO North America at Lincoln International, which publishes a quarterly mid-market index tracking 1,800 companies.
“Over the last 15 years, the middle market has become much more institutionalised,” Brown tells Private Equity International. “It is a sophisticated market with sophisticated investors. If you look at the returns over time, the alpha is just better over time.”
Mid-market funds can be found throughout this year’s PEI 300. New Mountain Capital (34) catapulted 40 places from last year to help muddle the definition of ‘upper-middle market’. Other risers include Madison Dearborn Partners (49), Gridiron Capital (222) and Alpine Investors (246). Then there are the large players with dedicated mid-market funds, such as Thoma Bravo (5). In addition to hauling in a record $17.8 billion for its flagship vehicle, Thoma Bravo Flagship Fund XIV, the San Francisco tech investor pulled in $3.9 billion for its third mid-market Discover Fund and $1.1 billion for its first lower-mid-market Explore Fund.
“Certainly, over the past 10 years, LP interest in the middle market has grown,” says Andrew Bernstein, senior managing director and head of private equity at Capital Dynamics. “There’s so much LP capital chasing the mid-market, even if you’re not the cream of the crop the floodgates are open.”
That flood of capital has made investing more challenging in an environment with too few deals. Managers must balance the pressure to deploy capital against regulatory uncertainty, the potential of fiscal tightening and ever-rising prices.
The hottest segment in the mid-market is tech M&A and within that sector high-growth software companies with “covid-resistant business models” are fetching the highest valuations, says Scott Wieler, CEO of investment bank DC Advisory US. In particular, demand has been “off the charts” for tech-enabled business services, education tech with online/hybrid delivery, healthcare IT, defence and infrastructure, he adds.
The mid-market price average for all sectors is 11x EBITDA, according to PitchBook, but multiples can easily go higher in certain sectors due to record levels of corporate balance sheet cash and PE dry powder, all-stock acquisition deals and hot public markets, including SPACs. A partner at an international law firm tells PEI he recently saw a healthcare IT company sell for an EBITDA multiple in the mid 20s.
“The mitigating strategy for high multiples is that firms are still able to get really good returns,” says Rebecca Springer, co-author of PitchBook’s 2020 Annual US PE Middle Market Report. “They’re buying assets at high multiples and selling them at higher multiples. A lot of add-on strategies that we’re seeing allow firms to buy a platform in the core middle market and move it into the upper middle market where there’s a ton of [competition for] high-quality assets, and sell it for a premium.”