What Is a Middle Market Firm?
The middle market is the segment of American businesses with annual revenues roughly in the range of $10 million to $1 billion, depending on the industry in which they operate. There are about 200,000 middle-market firms in the U.S., most of them privately owned or closely held, and their annual revenues combined total more than $10 trillion.
- Middle market businesses are too big to be called small businesses and too small to be big businesses.
- About 30 million Americans are employed by middle market companies, and their numbers are expected to grow.
- Businesses in this sector tend to be service-oriented and may be relatively unknown outside their industries.
- Middle market companies are often financed through business development corporations (BDCs).
- When publicly traded, middle markets tend to trade as small-cap or micro-cap stocks.
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Understanding Middle Market Firms
Middle market companies are responsible for about 30 million jobs and comprise about one-third of the annual $30 trillion in U.S. private-sector gross receipts. That makes the middle market a powerhouse of the U.S. economy, though many of these companies are little known to the general public.
The middle market is a critical sector of the American economy and an important engine of job creation, accounting for the majority of new U.S. jobs since 2008. Companies in this sector are heavily concentrated in service-oriented activities including business services, health services, and educational services. Significant numbers are engaged in retail or wholesale trade, construction activity, or manufacturing.
If the U.S. middle market was a country, its gross domestic product (GDP) would rank it as the fourth-largest economy in the world.
Middle Market Firm Characteristics
There is no universally accepted definition of the middle market. Traditionally, annual revenues were the key differentiator. The U.S. Department of Commerce defines the middle market as those businesses with pre-tax earnings between $5 million and $250 million. Others peg it between $10 million and $1 billion.
However, some analysts prefer to define middle-market firms by their asset levels or numbers of employees. Others characterize middle markets as companies with between 500 and 1,000-1,500 employees. By this reckoning, small businesses have 500 or fewer employees.
The lack of a clear delineation can result in some gray areas when attempts are made to group businesses by the classic three-level approach that includes small business, middle-market business, and big business. Some cut the categories down to two and label all but the biggest businesses as small and medium-sized enterprises (SME).
Challenges for Middle Market Firms
The interests of middle-market businesses may be relatively under-represented in policy and economic debates, from the local level to internationally. Most big businesses are publicly traded companies. They report financial information quarterly and employ lobbyists to represent their interests. Small businesses have associations that represent their interests. The middle market, by comparison, is more amorphous and less transparent. They are low-profile, and their products and services may be generally recognized only by their customers.
The COVID-19 pandemic also hit SMEs especially hard. In fact, 43% of middle-market executives believe the pandemic will have some adverse effects on revenues in 2021. Even discounting the effects of the pandemic, significant challenges remain. According to a 2021 report, maintaining customer relationships continues to be difficult, with a majority of middle-market executives citing this as one of their top challenges right now.
Managing workforce disruption and keeping employees engaged and productive also continues to be an ongoing problem for middle market leaders.
Relative to big public companies, middle-market businesses can have a tough time raising capital to expand or invest, and their costs of debt are typically higher. Although middle-market lenders, particularly boutique investment and commercial banks, aggressively compete for the business of the middle market, larger businesses enjoy the advantage of economies of scale. Many theories explain why this is the case but it often boils down to the added transaction costs banks undertake for due diligence and marketing activities when they cater to the middle market.
Middle market companies often look to business development companies (BDCs) for funding. These are similar to closed-end investment funds. Many BDCs are public companies whose shares trade on major stock exchanges. As investments, they can be somewhat high-risk but also offer high dividend yields.
To qualify as a BDC, a company must be registered in compliance with Section 54 of the Investment Company Act of 1940. It must be a domestic company whose class of securities is registered with the Securities and Exchange Commission (SEC).
By regulation, a BDC must invest at least 70% of its assets in private or public U.S. firms with market values of less than $250 million. The companies they invest in are often young businesses in need of financing or companies that are struggling to emerge from financial difficulties. The BDC is required to provide managerial assistance to the companies in its portfolio.
Investing in Middle Market Firms
Most middle-market firms are not publicly traded, but they can be found among small-cap or micro-cap companies. Middle market companies are not usually considered big enough to be mid-cap stocks, which are defined as having a market capitalization between $2 billion and $10 billion.
Investors may also be able to invest directly in the shares of business development companies that provide financing to middle-market firms. Because BDCs are regulated investment companies (RICs), they must distribute over 90% of their profits to shareholders. That RIC status, though, means they don't pay corporate income tax on profits before they distribute them to shareholders. The result is above-average dividend yields.
According to BDCInvestor.com, as of June 2021, the ten highest-yielding BDCs were posting yields from 9.19% to 21.99%.
Middle Market Company vs. Main Street Company
Main street companies are most often small businesses that employ a relatively small number of individuals and take in a modest amount of revenue. The middle market is a step up from this, with larger operations, more employees, and revenues in the tens to hundreds of millions of dollars per year.
The middle market consists of companies that would make up small-cap and micro-cap stocks when listed on exchanges. These can be riskier than holding shares of larger, more mature companies, which tend to be more stable. At the same time, the growth opportunities and ability to be nimble can often be greater for the middle markets, providing higher potential returns.