Distinguishing Middle Market Direct Lending
- Visual Guide
Tile 2.1
Non-Bank Lenders and the Rise of Sponsor Finance
Non-bank lenders have replaced banks as the main source of debt capital for sponsor-backed middle market companies.
A Shift in the Source of Funds for Middle Market Deals
Pitchbook, LCD, “High-End Middle Market Lending Review 4Q 2023.” Excludes data for 2020, 2022 and 2023 because PitchBook LCD did not have enough observations. Data series begins in 1997.
Regime Change
- Twenty years ago, the primary source of debt capital for middle market companies was regional commercial banks
- Many of these local banks were subsumed by national brands in the 1990s; then, new regulation further hindered banks from issuing smaller company loans, setting the stage for private direct lenders to step in
- Non-bank lenders brought distinct innovations (such as the unitranche loan) and offered a number of benefits (including speed, simplicity and certainty of execution) to the private equity firms driving most middle market transactions
- The relationship that grew between non-bank direct lenders and PE sponsors has developed into a win–win partnership that undergirds a long-standing symbiosis in the space.
Tile 2.2
Sponsor Finance and the Direct Lending Ecosystem
Sponsor Finance is a partnership between the Private Equity Sponsor,
the Target Middle Market Company and the Direct Lender.
How Sponsor Finance Gets Done
A Win–Win–Win Relationship
- At the heart of the direct lending ecosystem, you will find a trio of essential participants: the Private Equity Sponsor, the Target Company and the Direct Lender.
- To enable any middle market transaction to occur, the Private Equity Sponsor will seek out a trusted source of debt capital to support the deal’s financing.
- Sponsor Finance requires an integral partnership among this group to ensure proper alignment of interests across all participants.
Tile 2.3
Starting from the Middle: Not Too Big, Not Too Small
Middle market companies represent a critical but often overlooked segment of our economy.
The Private Market Continuum
It's Better in the Middle
- Middle market direct lending sits in the middle—between venture capital and large cap buyouts.
- Venture involves early-stage start-ups with little or no revenues funded by angel investors or venture funds.
- Large cap companies are either public already or supported by the largest private equity firms.
- While the two ends of this continuum get the most headlines, middle market firms represent the vast majority of U.S. companies, national employment and GDP and offer distinct investment attractions for both direct lending firms and private equity sponsors.
Tile 2.4
It’s Better in the Middle: More Room to Grow
We believe middle market firms offer greater upside potential to private equity sponsors than large cap buyouts.
Revenue and Profit Growth in Middle Market vs. Large Cap Private Equity Investments
Weighted Average Change in Revenue and EBITDA from Entry to Exit
Revenue Growth
EBITDA Growth
Source: MSIM database of transaction level information, including only U.S. deals and excluding Morgan Stanley transactions. Represents a sample of portfolio companies that report on EV, revenue, EBITDA, net debt and company status (public/private), with data as of 2023. MSIM analysis as of 2023. Given the sample universe and size, there is potential for selection bias. Middle market is defined as a transaction value of $500 million or less. Sample includes 166 total transactions—37 large-cap and 129 middle market. Analysis excludes outliers.
Attractions of the Middle Market
- Middle market companies are small or mid size by definition. That means they have more room to grow— making them highly appealing to private equity (PE) sponsors.
- PE sponsors’ primary goal is growing their portfolio companies, and success is measured by the difference between the price they pay on purchase vs. where they sell it.
- PE sponsors of middle market deals achieved revenue and EBITDA growth about three times that of large cap buyouts.
- They achieve this growth largely by organic means— expanding to new markets with new products to reach more customers—and by inorganic steps via acquisitions.
Table of Contents
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