Understanding the potential of middle market companies

Key takeaways

1. Middle market companies are substantial drivers of U.S. economic activity, generating over one third of private sector Gross Domestic Product (GDP) annually while employing nearly 50 million people.¹
2. Although there are around 300,000 companies in the US middle market,¹ name recognition remains low as they are often niche providers or value chain businesses that support and enable larger companies.
3. Understanding the types of companies and the role they play in an industry is critical to assessing the potential of these companies to grow into larger businesses.

The missing middle?

Current press surrounding private credit may lead you to believe that the market is a monolith – a large block of loans that broadly look the same. The reality is quite different. As the US$1.7 trillion global market (per Preqin as of December 31, 2023) continues to expand alongside demand from new investors, we see a significant need to improve transparency and understanding of private credit market segmentation, particularly in corporate direct lending, which is the largest sub-component of the market. Direct lending represents approximately 46% of the global market according to Preqin, while the rest of the market includes categories such as distressed debt, special situations, opportunistic and venture/growth lending.

Segmenting direct lending

The dinner table test: if you discuss middle market companies at the dinner table, will your family or friends know what you are talking about (or be able to name any of those businesses)? Most consumers are only aware of companies they encounter in their daily lives, such as small, locally owned businesses (e.g., pizza parlors, barbershops, plumbers, etc.) or larger public companies (e.g., Amazon, Apple, CVS, Home Depot, etc.^*). But what about the space between?

Sitting between the local pizzeria and General Motors* is a large subset of middle market companies that represent a driving force of U.S. economic activity. There are around 300,000 middle market companies in the U.S., generating more than US$13 trillion in annual revenue and employing nearly 50 million people.¹ That’s equivalent to over one third of private sector GDP and over 30% of private sector employment.¹ Businesses in the middle market are often integral to the consumer experience without broader name recognition. Parts suppliers to manufacturers have long been essential businesses, less widely known to consumers. Suppliers today are more often software or technology services companies that help manage consumer web engagement and user experience, organize payroll and scheduling, or optimize inventory management.

* Specific companies are mentioned for educational purposes only and should not be deemed as a recommendation to buy or sell any securities. Any companies mentioned do not necessarily represent current or future holdings of any BlackRock products.

Exhibit 1: Middle market scale

Middle market segmentation by number of business and total revenue

Middle market sectors

As reflected in Exhibit 2, the largest corporate sectors in the middle market are similar to high yield bond and bank loan markets and include information technology, healthcare, and business and financial services. The role of these businesses and how they seek to drive results often helps categorize them thematically rather than the more typical revenue or earnings segments.²

^{Exhibit 2: Middle market sector exposure}

Industry weights (based on fair value) of the Cliffwater Direct Lending Index

Roles of middle market companies in the economy

1. Value chain contributors– Larger companies often rely on middle market companies within their value chain to drive operating results. Some examples of middle market companies providing services seeking to unlock value for larger companies include retailers optimizing inventory management or staff scheduling, insurance companies seeking better insight into policyholder risks, and consumer services companies analyzing spend data that may help improve marketing return on investment. Middle market companies play a role to help improve outcomes for consumers and investors, both to companies in the middle market and to larger (and typically publicly listed) companies who recognize enhancements to the value chain via vendor relationships with these businesses.
2. Niche industry experts – To be an important business does not necessarily require the scale and complexity of a public company, and often this segment has a regional focus rather than a national or international footprint. Consider the supplier of drive through car wash equipment, the regional heating and air conditioning services provider, or the pallet manufacturer on which most goods transported by truck are moved. These companies provide niche capabilities that may make them valuable without making them necessarily large or even well-known on a national basis.
3. Innovative growth companies – BlackRock classifies these companies as those that have a unique product or solution that is disruptive within its industry, often beginning in the middle market. These businesses may start organically by founders on a mission to address a specific need, then gain scale through organic (i.e., growth) or inorganic (i.e., acquisition) transactions. We believe those taking a ‘buy and build’ approach may be of particular interest to private equity investors and are often the source of private credit lending opportunities as well.

Addressing the needs of middle market companies

Smaller businesses often need outside resources to advise and support their growth, including middle market companies. Financing partners are critical examples, as they can offer not only capital, but also sector experience and insights to the company. While no two companies are the same, industry expertise is a valuable tool. Regardless of sector or business model, underwriting loans to middle market borrowers requires deep industry expertise and the ability to assess a business efficiently. Tenured investment teams who have seen business cycles across sectors may be an effective lending partner to middle market borrowers and this may reinforce a manager’s ability to be a flexible strategic financing partner.

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