Middle Market Deals and how to buy, sell and raise capital from $5 to $500 million

How an entrepreneur chooses an intermediary to help with a transaction depends on a variety of factors.

There is not a bright line between what makes a middle market financial adviser a business broker or an investment bank.  Those monikers are typically self-selected.

Here are some considerations.

*The lower the transaction value, the more likely that a self-described business broker rather than a self-described investment bank is to tackle your deal.  To be clear, however, there is no line of demarcation and some self-described business brokers effect larger middle market transactions, while some self-described investment banks execute smaller middle market transactions, but this information is a fair guide as a rule of thumb.

Private Equity:  The monicker private equity, as used in the middle market arena, typically refers to private investment funds, managed by very well qualified management teams.  These funds invest in leveraged buyouts (LBOs) and management buyouts (MBOs), providing management teams and other would be acquirers with financial partners to provide the equity capital required to complete a transaction.

You may want to think of private equity funds as late stage venture capital funds, but it should be noted that the name private equity is sometimes applied to the broader industry of private equity and venture capital.   In one transaction we did recently, one fund that invested styled itself as a venture fund and the other styled itself as a private equity fund, suggesting the blurry line between venture capital and private equity. 

Private equity funds  use a variety of other names, including "buyout funds" and "merchant banks."   Some of the most well know funds include Kohlberg, Kravis and Roberts (KKR) and Bain Capital.

Management Buyout:  Management buyouts (MBOs) typically refer to leveraged buyouts led by the management of the company to be acquired.  There are all sorts of circumstances that lead to this situation, including corporate sellers that are divesting a division or retiring entrepreneurs.

The appeal of such transactions to those who finance them is the continuity of management.  The history of the company can more easily be leveraged to support the financing.

Managers vary in their appetite for MBOs.  Some are enthusiastic about participating more fully in the rewards of ownership for the companies they lead; others are more realistic about the risks of ownership and the risks of negotiating to buy a business from their current employer--quite a juggling act.

You may also want to check the Investopedia definition, which deals with larger transactions.

Leveraged Buyout:  A leveraged buyout (LBO) refers to the purchase of a business using debt (often referred to as leverage).  The notion of leverage as debt comes from the buying power the debt gives a relatively small amount of equity. 

You may find this Investopedia definition interesting, but I would caution that I have rarely seen deals with as little as 10% equity, as its definition suggests.

In the middle market arena, deals typically utilize something more in the range of 20 to 30% equity.  

A leveraged buyout typically includes several tranches of capital, including most of the following: senior debt, junior secured debt, mezzanine debt, seller financing or earnout, and the equity contribution.

Asset Based Lender:  Asset Based Lenders, frequently abbreviated ABL, specialize in making loans to companies that may not be able to qualify for the loans based on their income and cash flow.  In contrast to traditional commercial banks (though many ABLs are affiliated with banks) ABLs focus on assets.

Underwriting criteria of ABLs vary meaningfully, but they will generally lend up to 70 or 80 percent of company's eligible accounts receivable (A/R) and up to 50 percent (at most) of eligible inventory.

Eligible A/R will typically include accounts due from commercial customers with a good payment history; eligible A/R will typically exclude past due accounts and consumer accounts.  Adjustments are typically made for concentration, that is, having more than a threshold percentage of A/R due from a single customer.

Eligible inventory will typically only include finished goods inventory, located in domestic warehouses, excluding obsolete inventory, inventory in transit, work in process inventory and most raw materials.

ABLs are key players in the successful execution of leverage buyouts (LBOs) or management buyouts (MBOs), where the new structure of the company may not give a traditional bank the comfort to lend.