Capital

Access to Better Capital Drives the Mid-Market

Middle market companies remain a significant driver of the U.S. economy, but a majority of its businesses do not have sufficient access to capital. How can they meet their capital needs and what value-added, business-building insights can they expect from their lender?

The middle market is the great unheralded driver of the United States economy. These businesses — with anywhere from $10 million to $1 billion in revenue — employ

34 percent of the U.S. private sector workforce and in 2010 contributed $3.8 trillion to the nation’s gross domestic product. The U.S. middle market would be, by itself, the fourth-largest economy in the world, just behind Japan.

Yet, as impressive as these numbers are and as diverse as this group is, the middle market is too often ignored and overshadowed. On the top end, huge multinationals leverage their size and global name recognition to influence policymakers. On the lower end of the spectrum, small businesses have established themselves as the embodiment of intrepid American entrepreneurialism.

But the middle market’s disadvantage goes beyond a lack of attention. Access to capital has also been a problem since the financial crisis, as many lenders to the middle market either exited the business or dissolved. Today, global banks fight to serve the big multinationals, while the Small Business Administration helps promote and develop small businesses. The result is a financing gap for the middle market.

A recent survey by GE Capital and The Ohio State University’s Fisher College of Business found that 55 percent of middle market businesses do not have sufficient access to capital. Addressing this financing void can have a direct impact on the country’s economic growth and job creation. Consider that, during the recent downturn, middle market companies still managed to add two million jobs while large companies shed four million jobs.

As General Electric Co.’s Chief Executive Officer Jeffrey Immelt expressed in his keynote address at the 2011 National Middle Market Summit: “Job creation by and large has come from growth companies going through the $10 million revenue barrier up to $1 billion and beyond.”

 

Optimism and Opportunities

To better understand the middle market, the GE Capital/Ohio State study surveyed more than 2,000 chief executives and chief financial officers in private and public businesses. The results were eye-opening. There are 194,000 such businesses in the U.S. and it’s a segment characterized as a diverse group in terms of geography, industry and size.

In terms of size, there are three sub-segments of the middle market, each with distinct operational and financial characteristics:

▪ Businesses with revenues of $10 million to $50 million often operate more like small companies. They are typically privately held (94 percent), with a large percentage family owned and operated.

▪ Businesses with $50 million to $100 million in revenue are three times more likely to be publicly listed than smaller firms. They also have more mature business practices. Most set formal annual growth targets; they also invest in systems and business process development, training and education and research and development.

▪ Finally, those with revenues of $100 million to $1 billion are beginning to resemble multinational companies regarding sales force capabilities, customer focus, easier access to capital and a global footprint.

In terms of regional diversity, the Midwest is home to the greatest number of middle market companies (20.9 percent), while the West, at 18.6 percent, and the Southeast, with 16.4 percent, also have a large share. As for industries, services account for 31.3 percent of middle market companies, followed by manufacturing, at 17.3 percent, wholesale, at 13.8 percent, and retail, 12.4 percent.

About one million of the two million jobs created by the middle market from 2007–10 came from the services sector and about 240,000 from manufacturing. The remaining new jobs were spread evenly between financial services, retail and wholesale, trade and transportation.

The top five employee growth industries for the middle market revealed in the survey are: computer/IT programming (up 67 percent), commercial research/R&D (up 31 percent), collections (up 30 percent), executive placement (up 29 percent) and business consulting (up 24 percent).

This job creation among middle market companies occurred across nearly every region of the United States during this period. For example, while large Midwestern businesses cut 4.9 million workers — representing a 35 percent regional reduction of their workforce — middle market firms added nearly 500,000 in the region. Further, this 5 percent increase in jobs at middle market businesses was broadly spread across all business sectors in the region.

Looking forward, middle market executives are generally optimistic about their own growth prospects — 80 percent expect to grow this year. But expectations are tempered by low confidence in their local economy and the broader U.S. economy. There are concerns about inflation (37 percent are unable to pass along rising commodity prices to customers), a frustration with insufficient access to the capital markets (as noted, 55 percent identified this as a problem), threats from global competition (45 percent cited this issue) and 75 percent said the cost of regulatory compliance is burdensome.

 

Growth Champions

Even in the face of past and present challenges, the survey uncovered a group of middle market companies that have fared exceptionally well. These “growth champions” — the top 9 percent — are growing at a rate of 10 percent or greater per year. There are commonalities among these companies that are instructive. The leaders share five key strategic priorities:
▪ Focus on Innovation.

The strongest common theme among growth champions is a relentless focus on innovation. Continuous innovation is seen as a key to survival and critical to competing with larger businesses. Growth champions typically invest almost 2.5 times more in R&D per sales dollar than do lower-growth middle market firms, and have dedicated funding for it — 44 percent of growth champions have dedicated funding for R&D compared to 25 percent among other such companies.

In addition, 54 percent of growth champions invest in innovation and new product development compared with 29 percent of the rest of the middle market, while 66 percent invest in new processes compared to 43 percent of the rest of their peers.

 

▪ Strong Management Culture.

Growth champions also do a better job developing management capabilities. They typically articulate a corporate vision, develop aligned business strategies, institute robust processes and manage their performance well. From a strategic planning perspective, 57 percent of growth champions have long-term growth strategies compared with only 26 percent of middle market organizations. Growth champions also say (at twice the rate of the rest of the group) that they have a diversified funding strategy in place.

Growth champions hold themselves more accountable — 66 percent have a formal growth target for the next fiscal year, with 58 percent saying they have formal processes to track their progress toward this goal (with the corresponding figures of 31 percent and 33 percent, respectively, for the rest).

 

▪ Sharp Customer Focus.

Growth champions invest heavily in customer relationships to attract new customers and enter new markets. In fact, 62 percent of growth champions consider themselves adept at attracting new customers compared to only 40 percent of other companies in the middle market.

Furthermore, 72 percent consider themselves good at strengthening customer relationships.

Nearly half of the growth champions say they have leading marketing and communications capabilities, and about the same number say they are investing to develop further capabilities in sales and marketing.

In the rest of the segment, by comparison, only 28 percent say their marketing and communication capabilities are industry leading, and just 35 percent say they are investing in sales and marketing.

 

▪ Exceptional Talent Management.

For most middle market companies, the need to focus on talent becomes important as they gain critical mass and transition from operating like a small company. But many say they have difficulty attracting and retaining talent.

Growth champions, though, stand out for their success in attracting talent by offering innovative career development training, stock options and attractive compensation structures. About half of growth champions say they have both access to the skilled workforce necessary for their organization and the recruiting power to attract that talent. Only 36 percent of the rest of the segment say they have access to talent and just 28 percent have what is necessary to attract it.

Interestingly, results-driven variable compensation is becoming the norm in the growth champion segment, with 55 percent reporting having some form of variable compensation program.

▪ Broad Geographic Vision.

Growth champions clearly articulate the need for a larger and broader geographic vision — whether in the form of manufacturing, sourcing footprint or in finding new opportunities in fast-growing foreign markets for their products and services.

Indeed, they view broader geographic expansion as essential to growth and business success: 39 percent see expansion beyond the U.S. as absolutely essential (compared to 16 percent for the rest of the segment) and close to half are identifying and working on global opportunities compared to 32 percent of the other middle market peers.

Depending on the industry in which they operate, some middle market companies may even start with a global sales and marketing strategy. Not surprisingly, 44 percent of growth champions operate globally and 37 percent use global suppliers, compared with 18 percent and 16 percent, respectively.

In the U.S., 65 percent of growth champions are expanding from a local/ regional focus to the larger national market while only 39 percent of other middle market organizations are doing so.

 

Access to Capital and Expertise

Maintaining this level of commitment to growth requires continuous access to capital throughout the business cycle. Many middle market companies are struggling to get the financing they need to grow. But factors besides a company’s cash flow and credit history can influence the outcome of a credit application.

By keeping a few rules of thumb in mind, companies in this segment can improve their likelihood for success.

  1. Reach out early. Approach a lender before capital is needed.
  2. Find a lender who understands the company’s industry.
  3. Think like a lender. Understand the application and review process.
  4. Sweat the small stuff. Get appropriate documents in order.
  5. Truth trumps all. Be transparent.
  6. Optimize cash flow. Show how the company is maximizing efficiencies.
  7. Tell a compelling story. Acknowledge challenges and highlight successes.
  8. Do the necessary homework. Know competitors’ financing structures.
  9. Relationships matter. Treat the lender as a strategic supplier.
  10. Communicate, communicate, communicate. From day-to-day details to big changes, keep the lender informed.

 

Though important, capital alone is not enough for success. Strategic insight is necessary and middle market companies should be seeking these insights at every turn along with access to capital. One potential source of such expertise is a company’s lender. When choosing a lender the interest rate obviously matters, but it’s also important a lender understands the industry and can be a long-term partner to help build the business.

As the survey makes abundantly clear, the health of the middle market is vital to overall U.S. prosperity. For this segment to remain dynamic and growing, it needs access to appropriate capital and expertise.

This article first appeared in Financial Executive magazine.