The Real Hot Commodity? Mid-Market Businesses

Gold sits near record highs, oil continues to drive nation states and rare earth minerals are reshaping geopolitics and grabbing headlines.

But today’s truly hot commodities are America’s unheralded mid-market businesses, specifically those we call the “Upper Middle Market”—those businesses between $50 million and $1 billion in revenue that readers of Chief Executive magazine most commonly run. The gold rush won’t be slowing anytime soon.

Between 2019 and 2024, the average EBITDA multiple for transactions between $10 million and $250 million—across all industries, geographies and quality of earnings—went from approximately 6.6x to 7.1x by the middle of last year—despite the wild market gyrations fueled by Covid and inflation.

You can thank the private equity industry for that. PE, as you all know, has become a behemoth, gobbling up these businesses with little concern for whether they make networks (Barracuda Networks) or noodles (P.F. Chang’s).

Any mid-market CEO who has ever sent an email gets regularly bombarded by ambitious private equity principals, ready to wine, dine and fawn over you in an effort to pry your business from your hands (into their pockets) without competition. Without your business, they can’t deploy capital, earn their fees and share of the flip. We’re already seeing a reduction in returns for many firms, and fundraising has become a winner-take-all proposition, with the largest firms gaining the vast majority of new investments.

It speaks to a fundamental—and under-discussed—math problem that private equity is facing. An oft-used PE tool is to examine the Total Addressable Market (TAM) of a potential target company. Utilizing their own TAM tool, you quickly see PE has a structural problem that limits their growth potential—and will likely continue to drive up prices for mid-market businesses.

There are an estimated 18,000 private equity firms in the U.S., up nearly 60 percent in just the last five years. These firms have an estimated $1.6 trillion in funds raised but not yet spent (“dry powder”).

At the same time, there are only ~49,000 upper-middle market businesses, according to the U.S. Federal government’s official Business Census. Private equity already owns around half of the available pool. Many of the rest are not (and may never be) for sale.

Some may think that relief for private equity can come from buying even larger companies, those with $1+ billion in revenue. But the math there is even worse: there are only 3,354 of these companies in the U.S. Many of these businesses are publicly traded, making PE ownership very difficult (and expensive). That’s why private equity keeps hunting for smaller companies in the lower middle market.

So whether an exit to private equity may or may not be in your future, it pays to get your organization in top shape. Some essentials include:

• Develop Your Story. Work to build a solid, attractive and clear narrative for your business that will be enticing to potential buyers. It will need to be tailored, depending on the potential audience, so make sure you practice until it is second nature.
• Know the Market for Your Company. Take time to meet with investment bankers regularly to understand who might be in the market for you and what they value most—this can help you develop a more focused value-creation strategy with higher exit multiples rather than growing the business equally across all areas.
• Think Like a Buyer: Be ready to show potential investors how they’ll profit post-sale by showing them a multi-year strategy for enhancing company value, focusing on operational improvements, additional M&A targets, digital transformation, etc.
• Focus on Key Talent Retention: Implement strategies to attract and retain top talent, as a strong management team adds significant value and appeal to potential acquirers.
• Get Your Data Ready. The time to have your financial house—and your data house—in order is long before you start meeting with potential buyers. Understanding what buyers will want—in detail—and making it easy for them to access it is essential. Consider hiring a consulting CFO focused on M&A projects to help here so you don’t disrupt the business.

The time to take on this work is long before you have to. And remember, the next time you read about hot commodities or other trending investment idea: You’ve got the hottest asset of all.