Private Debt: The Core Middle Market

Middle market companies in the U.S. are those with annual revenues between US$10 million and US$1 billion. Definitions vary throughout Europe – in the U.K. and Germany, they are defined as those with annual revenues between €20 million and €1 billion, while in Italy the range is typically from €5 million to €250 million¹.

There are roughly 200,000 such businesses in the EU and an equal number in the U.S. They are responsible for roughly one-third of U.S. employment and GDP. And they drive a similar percentage of Europe’s economic activity¹.

The middle market has seen double-digit annual growth in both revenue and employment in 2022 and 2023¹. Despite its collective size and economic might, the middle market today lacks the capital and financing options it once had.

A need for capital

The past 20 years have seen traditional banks pull back from financing middle market companies. This has opened the door for private lenders to increasingly become the main - and sometimes only - option for middle market borrowers.

Core opportunities

Amid a favorable environment for private lenders across the middle market, we see particularly compelling opportunities in the core segment, which we define as companies with an annual EBITDA between €10 million and €50 million in Europe, and US$25 million and US$75 million in the U.S. Deals in this space are usually underwritten by either a single lender or a club of no more than five institutional investors.

The loans require more extensive due diligence, and this can make sourcing deals more challenging at scale. Smaller companies can also bring higher business and operational risks.

In addition, we see significant upside in the core middle market compared with the upper middle market, where there are more lenders competing for deals. Reduced competition in the core middle market offers wider spreads to lenders, providing greater agency over pricing and better opportunities for outperformance.

Investor protections are one major reason we like the core segment. Smaller borrowers are typically more amenable to providing lenders with covenants and other protections.

Challenges and opportunities

The market for middle market loans is spread out geographically and across industries. Sourcing the right opportunities can be challenging, given the breadth of companies and the limited information available to lenders. Venture capital and private equity firms can be a reliable pipeline for private lenders, and these relationships are essential in this space. Loans to companies backed by these investors are referred to as sponsored financings, with the sponsor often playing a big role in soliciting and negotiating the loan.

Non-sponsored loans are those made to companies that lack the backing of a venture-capital or private-equity investor. Rather, the lender works directly with the company, often without a bank or other intermediary.

Lending to non-sponsored companies typically requires an experienced lender with the resources and expertise to complete a more hands-on due diligence and credit analysis.

It’s important for lenders to access different sourcing channels in response to market events, so if sponsor-backed M&A activity slows down, investors can still access non-sponsored deployment opportunities without sacrificing on key terms.

The importance of middle market companies to the global economy makes it essential for them to access capital when they need it. And we believe that this segment offers unique opportunities to the lenders who provide the requisite capital to these companies as they continue to expand their operations.