Financing the Lower Middle Market

Not a market in the useful sense

A market implies many participants pricing a comparable instrument continuously. Capital for a company in this band does not behave that way. Each provider has a mandate with hard edges — cheque size, sector, structure, control, geography, whether they can hold a minority, whether their own fund is in its investment period.

A company that fails one of those edges is not priced worse by that provider. It is not priced at all. The provider's answer is no in a form that resembles a valuation disagreement, which is how founders come to believe they have been marked down when they have simply been screened out.

The set of parties who clear every edge for a given company is small. It is also specific to that company, and it changes over the eighteen months a raise is being contemplated as funds close, deploy, and reset.

The list the founder has

Most founders assemble their list from three sources: the funds that have already approached them, the funds their peers used, and the funds that appear in the trade press for their sector. Each source is biased toward parties who are visible rather than parties who are appropriate.

Inbound is the worst of the three, because it selects for whoever is running the widest outbound programme this quarter. That is a fact about the fund's origination budget, and it carries no information about whether they can price the risk.

The result is a raise that reaches thirty parties, of whom perhaps four could ever have transacted. The founder reads a low response rate as a verdict on the company.

Structure is where the answer usually is

A business that cannot be funded as growth equity at the price the founder wants is frequently fundable as a structured minority, a unitranche with a small equity strip, a sale of a division, or a partial secondary that resets the cap table before the primary is raised.

Each of those has a different set of providers, and the sets barely overlap. Choosing the structure first narrows the search enormously; running the search first and letting the market suggest the structure produces a long process and a worse outcome, because the parties who reply are the ones with the loosest mandate rather than the best fit.

What the process actually is

A raise in this band is a search problem over a defined and knowable set, conducted in the right order, with the first conversation held with a party who has done this shape before. It is not a marketing exercise, and volume works against it — the same document sent to sixty parties is read as a document that was sent to sixty parties.

The work sits in the definition of the list, before anything is sent.