Middle Market

The middle market is a classification for companies that are too large to be considered small businesses but not yet large enough to be classified as big corporations. While there's no single, universally agreed-upon definition, these companies are typically categorized by their annual revenue. In the United States, this often means revenues between $10 million and $1 billion. In Europe, the definition can be similar, though sometimes lower thresholds are used. Think of them as the vast, often unseen, landscape of established companies that sit between the local bakery on the corner and global giants like Apple Inc.. This segment is a critical engine of economic growth, responsible for a significant chunk of a country's GDP and new job creation. For investors, the middle market represents a unique territory, often less scrutinized than the big leagues, potentially hiding undiscovered gems with significant growth potential.

Often overlooked in the headlines that favour S&P 500 titans, middle-market companies are the backbone of modern economies. They are diverse, operating in nearly every industry, from manufacturing and logistics to technology and healthcare. Unlike small startups that are still finding their footing, these firms typically have proven business models, established management teams, and a loyal customer base. However, they differ from large corporations in crucial ways:

• Ownership: A large percentage of middle-market companies are privately owned, often by their founders, families, or a group of private investors like a Private Equity firm. This contrasts with large-cap companies, which are typically publicly traded with thousands or millions of shareholders.
• Access to Capital: They have outgrown the capacity of small business loans but may not yet be large enough to easily issue public stocks or bonds. This unique position creates a specific financing need that specialized lenders and investors aim to fill.
• Visibility: They operate “under the radar.” They are not household names and receive little to no coverage from Wall Street analysts, creating a very different information environment for investors.

For the savvy value investor, the middle market is fertile ground. Its relative obscurity can lead to market inefficiencies and opportunities that are scarce in the highly competitive large-cap space. While you can't just buy shares of a private family-owned factory on your brokerage app, there are clever ways to gain exposure.

The key is to invest through specialized vehicles that focus on this segment.

1. Business Development Companies (BDCs): This is the most direct route for retail investors. Business Development Company (BDC)s are publicly traded companies (you can buy them just like a stock) that invest in or lend money to private middle-market businesses. By buying shares in a BDC, you are effectively hiring a professional management team to find, vet, and manage a diversified portfolio of these companies for you.
2. Private Equity Funds: While direct investment in a PE fund is typically reserved for institutional or accredited investors with high net worth, understanding their strategy is crucial. PE firms are major players in the middle market, often acquiring companies through a Leveraged Buyout (LBO) with the goal of improving operations and selling them for a profit years later. The success of BDCs is often linked to the same principles.
3. Publicly Traded “Small-Caps”: Some smaller companies trading on public exchanges like the NASDAQ in the U.S. or AIM in the U.K. can fit the revenue profile of a middle-market firm. These can offer direct ownership but require thorough, independent research.

The middle market aligns perfectly with the core tenets of value investing.

• Inefficiency and Mispricing: With few to no analysts covering them, the market price of BDCs or smaller public companies in this space is more likely to diverge from their intrinsic value. A diligent investor can uncover a Mispricing that the broader market has missed.
• Growth at a Reasonable Price: These companies are often at an exciting inflection point. They are established enough to be stable but nimble enough to grow much faster than a behemoth like Microsoft. The challenge is to buy into this growth without overpaying.
• Tangible Value Creation: Investors in BDCs or PE firms aren't just passively holding stock; they are backing managers who actively work with their portfolio companies to improve performance. This can involve professionalizing a family-run business, financing a strategic acquisition, or streamlining operations—creating real value beyond financial engineering.

Investing in the middle market is not without its risks, and a clear-eyed approach is essential.

• Liquidity Risk: Investments in the underlying private companies are highly illiquid. While BDCs are publicly traded, their shares can sometimes have lower trading volumes than large-cap stocks, which can lead to wider bid-ask spreads.
• Economic Sensitivity: Middle-market companies can be more vulnerable to economic downturns than their larger, more diversified counterparts. They may have fewer cash reserves and a more concentrated customer base.
• Management is Key: When you invest in a BDC, you are placing immense trust in its management team. Their ability to perform Due Diligence, structure deals wisely, and manage the portfolio is paramount. Before investing, thoroughly research the BDC's leadership, their track record, their fee structure, and their investment strategy.