2. The Growth of Middle-Market Deals
Middle market deals have always played a big role in private equity. Even large firms like Bain Capital and KKR were involved in the middle market in the early days because they were investing small funds and were capital constrained. As larger pools of capital have been raised, the private equity market evolved, and middle-market transactions have occupied a greater share of deal volume while also growing in size and prominence.
According to Pitchbook, U.S. middle market deals have steadily accelerated in both number and value over the last decade, from 1,315 deals in 2010 to more than 3,100 deals in 2019, and from $193 billion to $531 billion in enterprise value in 2019.
One of the reasons middle-market private equity investments have performed so well is that there is a greater ability to impact results and add value than there is with large cap companies, which typically already have the scale and resources they need. Middle market companies may be lacking resources and experience that private equity is in an ideal position to provide, such as support for add-on acquisitions, operational improvements, and management talent
Large cap companies also tend to be highly correlated with public markets. The relative lack of correlation in the middle market makes it attractive to institutional investors. They can get liquidity from their public equity investments, and supplement it with middle-market private equity investments that provide better diversification.
3. Less Reliance on Leverage
The use of leverage in private equity is another area where we have seen a sea change in perspective. Transactions in the industry’s early days were far more reliant on leverage than the deals we typically see today. In particular, higher levels of debt were used relative to the purchase price. Of course, decades ago deals were being done at quite low multiples, and it was possible to buy companies with an equity contribution of 25% equity or less.
Today, equity may represent 40-60% of the purchase price, with more moderate use of leverage. Indicative of this trend, equity contributions to private equity deals were up four percent from 2018 to 2019, according to LCD. The industry’s strategic focus has changed accordingly, from breaking up diversified conglomerates into pieces and employing financial engineering to deliver returns to building and investing in businesses to grow revenues, create jobs, and increase profitability.
We have learned that you need a different thought process to calibrate the appropriate amount of leverage for a company that is or may be facing stress or distress due to industry headwinds or challenges in product or service delivery. Less leverage is often a competitive advantage for these businesses, particularly in times of uncertainty, as we have seen during the pandemic. Additional financial flexibility and operational support also allows management teams to invest in growth opportunities when competitors may not be able to, and to pursue add-on acquisitions or business partnerships that can drive revenue and market share gains.
As we look to the future, we believe that private equity will be an increasingly pivotal asset class – one that will play a growing role as an engine of economic growth and positively influence people’s everyday lives. We look forward to being part of this exciting evolution.
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December 03, 2020 at 12:50AM
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25 Years in Private Equity: Three Key Evolutions - Middle Market Growth
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