Mid-market lending: Sizing up the opportunity

The mid-market lending strategy may not be new to private debt but its significance is growing as a steady flow of new entrants add to a pool of industry incumbents.

Even as the asset class has mushroomed, though, it has remained nebulous, with no definitive word on what constitutes the mid-market or the average size of a mid-market investment fund. There are multiple types of vehicles that make up the mid-market ecosystem, including private funds and business development companies, both public and private.

While there is no standard textbook definition of the mid-market, industry participants have a clear idea of their own definition. Jessica O’Mary, a partner in Ropes & Gray’s private funds practice, notes that one manager might define businesses with an EBITDA between $5 million and $50 million as mid-market while another might define that bracket as $10 million to $100 million. 

Oaktree Capital Management’s in-market direct lending vehicle considers the mid-market to be companies with between $10 million and $50 million in EBITDA and businesses with revenues of between $50 million and $1 billion, according to documents from the San Joaquin County Employees’ Retirement Association. 

Brett Hickey, the founder and chief executive of Star Mountain Capital, has yet another definition. He considers it as businesses with $20 million to $100 million in EBITDA. Hickey added lower mid-market generally ranges from $3 million to $20 million in EBITDA.

The size of funds being raised to pursue the strategy can also vary greatly. 

O’Mary says this will always depend on their investment mandate. Frequently, senior loan-only funds can amount to just $200 million, she says, whereas those that invest up and down the capital structure are usually targeting at least $500 million. Increasingly, however, many funds are raising $1 billion-$2 billion.

“Firms now are trying to raise bigger and bigger funds,” O’Mary adds. “They’re also trying to manage single LP funds alongside those.”

Garrison Investment Group’s debut Middle Market Funding vehicle had a $300 million target, while it upped the goal for its second to $500 million, according to PDI data. Both are senior debt origination funds.

On the larger side, Bain Capital Credit raised $1.38 billion for its Sankaty Middle Market Opportunities Fund II, a 2013-vintage mezzanine debt fund – Bain rebranded its credit unit from Sankaty in April 2016. The Carlyle Group, meanwhile, is raising a $1.5 billion, 2017-vintage senior debt vehicle to target mid-market opportunities. 

In addition to private funds, there are BDCs that vary in size. Some might have assets worth $200 million in assets, while others number into the billions. There has been a proliferation of BDCs too, ballooning from a handful in the early 2000s to dozens of publicly traded vehicles today. 

Another trend in mid-market finance is the proliferation of sponsorless deals. Debt providers that do sponsorless transactions are often attracted to the extra premium they can earn for their investors. Because those alternative lenders lack a private equity firm in the deal, the firms must do extra work and due diligence, which can mean higher returns.

Hickey says the number of these deals is increasing with deals done on both the larger and smaller ends of the mid-market, though they are more prevalent on the lower end. 

“I think you have more [independent sponsors] and they are coming from a lot of different places. The spectrum of types and quality varies widely,” he adds, including seasoned private equity investment professionals who opened shop on their own, and less experienced players. 

Hickey says his firm participates actively in smaller sponsorless deals with the resources and capabilities to analyse and manage these types of deals, which require more effort to properly invest.

There has also been a surge in unitranche offerings, which blend senior debt and junior debt, particularly in Europe.
According to a recent report by bfinance, unitranche deals can make up 30-80 percent of a European fund.

Specifically, in the UK, more than half, 52 percent, of direct lending deals between October 2015 and September 2016 were unitranche.

While in the US, there have been some notable examples such as Thoma Bravo’s buyout of Qlik Technologies that included a $1.08 billion unitranche led by Ares Capital Corporation, a deal in which TPG Specialty Lending and Golub Capital also participated. The deal’s size showed unitranche has established itself as a scalable alternative to a first lien-second lien deal structure.