Partnering for Growth: The Art of the Middle Market

Lost amid the perfect storm of a volatile stock market, fears of recession and French rogue traders is the fact that private equity deals are still being completed. Incessant headlines trumpeting soured deals among mega funds continue to obscure the fact that, for the rest of the private equity industry and the entrepreneurs with whom we work, turmoil in the leverage market underscores the relative virtues of the “buy and build” strategies from which many entrepreneurs and PE investors have long benefitted.

Putting the “equity” back in private equity leaves firms like ours exactly where we want to be and where we can excel. Namely, partnering with talented entrepreneurs and seasoned management teams to create platform companies founded on the premise of growth – both organic and acquired.

A revitalized emphasis on long-term, strategic-oriented partnerships is precisely what’s called for when a tight credit market rears its head. That is why businesses that are considering working with a private equity firm for the first time risk selecting the wrong firm if they overlook the non-financial aspects of the relationship.

The fact is, owners and senior management of private businesses would do well to think about money last when considering taking on a private equity investor for the first time. For companies that have progressed beyond seed investors, selecting a private equity investor is one of the most critical decisions they will ever make. This is particularly the case for growth- or middle-market companies. The tremendous growth in the number of private equity firms serving the middle market over the last decade alone has made PE-firm due diligence as important for the company as it is for the private equity firms, particularly in these uncertain times.

To be clear, Halyard Capital defines the middle market as those companies with revenues ranging from $10 million to $250 million, well below the Fortune 500 but one of the fastest growing and largest segments in the business landscape. We typically invest in businesses with enterprise values of between $50 million to $250 million.

Businesses turn to private equity for a variety of reasons, typically after reaching a point in their lifecycle where financing solutions are inadequate to reach the next level of growth. Other reasons can include the need for liquidity for founders who are looking to take some money off the table after years of re-investing profits.

Companies that have venture capital investors will have gained some experience with outside investors. Nonetheless, it requires a related but different set of skills for a company to make a sizeable jump in scale.

There are at least four critical elements that business owners must regard when considering working with a private equity firm, especially for the first time:

Chemistry and Alignment
Business owners and managers need to believe that they can put their trust in a firm, and would enjoy working with them on a shared vision for their company.

Since middle market deals are less dependent on leverage than deals in the LBO market, the credit crunch has not deeply constrained availability of capital. That dynamic heightens the emphasis on private equity firms that have solid industry relationships, affording greater access to product creation, sales and distribution channels.

Industry and lifecycle experience
With the mushrooming of middle market private equity firms, deep knowledge of an industry sector becomes a crucial differentiator. Businesses need to find not only financial experts but industry experts. Similarly, experience with companies at different points of the corporate lifecycle (e.g., turnaround, later-stage) is also important.

Operational expertise
Putting money to work effectively is both a strategic (long term) and a tactical (short term) skill set. Both capabilities are essential for success. Private equity firms need to be able to provide both capabilities or ensure the presence of these capabilities through third parties.

Experienced negotiators know the best deal is one that works for all parties. The most valuable asset a private equity investor brings to the table outside of capital is the ability to be a true business partner. Absent that dimension, you’re missing out on the most important ingredient of all. The private equity firm may make the investment, but it is the individuals with whom you will work with as partners who will ultimately build and determine shareholder value.