SPECIAL REPORT:<br/>THE US MID-MARKET(12)

Who is likely to weather the credit crunch better?
Whether you're large market or mid-market, the strategies that are going to do well in this interim period are deals that require more equity. For example, where you're over-equitising the platforms and adding on debt as you make acquisitions. Also, deals that are focused more on growth will do well, where a lot of debt is not being added to a growing business that might be cash flow negative as it rapidly grows out. We're seeing a lot of these strategies. This being said, the mid-market does pursue those strategies more often than the mega-caps that are looking for large stand-alone buyout opportunities. I would say that the mid-market for the most part should be less affected, short term, by this lack of activity on the credit side. However, if mid-market players are looking to finance stand-alone buyouts, even for deals between $500 million and $1 billion enterprise value, it is hard to find financing. But for all these strategies, if we should head into a recessionary environment, that's where everything's really going to slow to a trickle – and that's going to affect everybody.

Will small-cap funds suffer as mega-funds move into the mid-market?
Obviously having a brand that has a high degree of credibility with Wall Street could be helpful when financing is needed, especially in the current environment. Moreover there are no lack of names and funds being formed in the mid-market, and if you come in with a name that's recognizable, with this umbrella of credibility, does that, all things being equal, give you a slight edge? Perhaps. Having said that, if you are a mid-market fund that's focused solely on enterprise software and you are experts in that space, I think those firms would be able to outmanoeuvre the generalists all day long. So I think there's plenty of opportunity for both.

From the perspective of a fund of funds manager, do brand-name larger firms entering the mid-market space or traditional mid-market firms make more appealing investments?
I think fund of funds managers definitely will find that they're comfortable with strategies like TPG's Star fund and Silver Lake Sumeru, because they're looking for something that has an edge. I think that certainly in these early stages of seeing these strategies play out, these funds will have an edge because they're bringing a lot of the shine and goodwill from the large managers. But because a lot of these large funds are essentially becoming sponsors for mid-market funds, down the line fund of funds managers will be looking at how much the team on the ground is getting of the carry and how much are they giving to the sponsor organization, especially when you're on fund II or fund III.

Fund of funds managers dislike any kind of uncertainty in a fund's management, and they may be concerned that there might be some volatility in ownership if the team on the ground at some point decides that they have their own relationships, their own level of sourcing, and they don't need a sponsor any more. The teams may not want to give up parts of the carry to a sponsorship organisation that isn't really adding as much value as they used to. I think that's really the key in the future.

For now, the sponsor organizations are adding a lot of value to the funds. The people running mid-market funds right now might find that the world treats them differently if they have an affiliation with a larger name. They might be the same managers, doing the same deals, and have the same profile, but they are treated differently, in a good way. How long that shine lasts is the key, but these funds have definitely gotten attention.