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Challenges and Opportunities for Businesses and Investors in the U.S. Lower Middle-Market

By Brett Hickey
Posted: 3rd March 2017 09:07
There are challenges and opportunities for investors and business owners in the U.S. lower middle-market. This is largely driven by the supply-demand imbalance from (i) over 175,000 businesses that have between $10 million and $150 million in annual revenues and (ii) a limited amount of capital focused on this marketplace. This supply-demand imbalance is mainly driven from the labour inefficiencies of working with smaller businesses. Therein lies challenges and opportunities for both businesses and investors.
Many high quality business owners are looking for growth capital to take advantage of technology investment opportunities to grow their businesses, make strategic acquisitions, or buy out retiring partners. At the same time, the more efficient capital markets participants including larger asset managers, commercial banks and investment banks, do not focus on these smaller companies due to the amount of labour, relative to fees, available. This leaves boutique players and investors who are able to be more focused on the returns from their investments as opposed to the amounts of capital they manage. An article published on 24 February 2017 from Institutional Investor by Christopher Schelling from Texas Municipal Retirement System partially discusses these challenges when looking at the amount of fees which can be generated on assets relative to returns from assets, making it compelling to scale assets even if at the expense of returns [1].
Star Mountain has one of the largest sets of proprietary data and information on the U.S. lower middle-market which spans decades of investment experience. Focused exclusively on the U.S. lower middle-market, Star Mountain has custom-built technology providing insights from proprietary data on over 5,000 investments dating back to 1991. This information helps Star Mountain develop leading investment products for its clients which are predominantly institutions but also include family offices and high-net-worth individuals. This data, research and experience also helps Star Mountain understand the true value drivers and typical risks faced by small and medium-sized businesses in order to help them strategically navigate threats and opportunities to maximise stakeholder value.
Star Mountain’s research shows that maximising value for established small and medium-sized businesses comes from (i) strategic acquisitions, (ii) growth initiatives (such as new distribution channels), (iii) technology development and implementation, (iv) team and culture building and (v) mitigating risks by methods including diversifying customers and suppliers.
U.S. Lower Middle-Market Overview
The U.S. lower middle-market has always been inefficient relative to other markets where investments can be processed faster (e.g. consumer / online loans) or where investments are larger and can be underwritten more efficiently. The supply-demand imbalance for growth capital to lower middle-market companies that have roughly $3 to $15 million of annual EBITDA and $10 to $150 million of annual revenue has further increased in many cases due to (i) larger asset managers continuing to grow in size and needing to more efficiently deploy capital in larger companies, (ii) downward pressure on management fees for credit funds, making it less practical to make smaller, more labour intensive investments, (iii) bank regulation, (iv) banks merging, needing to more efficiently deploy capital and (v) banks often being publicly traded, keeping a tight eye on shorter-term costs making it less likely to develop labour intensive parts of their business.
While the current credit climate may be efficient for larger businesses, there are many high quality business owners in the lower middle-market who have difficulty accessing the necessary resources needed to grow their businesses. This is particularly true where businesses need to access capital for non-asset based loans (e.g. to buy out a retiring business partner, to finance an acquisition or to finance rapid growth needs).
Star Mountain’s experience has been that when growing businesses have a valuable need for capital (e.g. to finance an acquisition at an attractive price) they are willing to borrow money at a high rate, for a short-term period, in order to substantially increase the long-term equity value of their business as a win for business owners, the economy and investors.
Star Mountain’s research show loans typically repaying in under four years, from (i) the cash flows of the business, (ii) the business selling to a strategic or private equity buyer who is able to run a more efficient capital market process seeking lower cost financing, or (iii) refinancing to a traditional commercial bank once the growth has been achieved and stabilised.
Evolution of the U.S. Commercial Bank Market
The number of commercial banks in the U.S. continues to shrink, decreasing from approximately 12,000 in 1990 to less than 6,000 in 2015 (see Figure 1). In addition, many banks and traditional lenders cannot efficiently provide capital to small companies because of the specialised resources required to source, underwrite and manage small loan exposures, as well as regulatory constraints. As a result, banks focus on loans that are simple to underwrite, such as those collateralised by real estate or accounts receivable, larger borrowers, and companies owned by private equity firms.
The U.S. government census estimates that there are over 175,000 companies in the US with $10 million to $100 million in annual revenues. When these companies seek capital for growth initiatives, acquisitions or ownership transitions there is often a lack of capital available, particularly for those with less than $15 million of EBITDA.
Only 8% of capital raised by private capital funds is focused on the smaller market by nature of those funds with below $200 million of AUM. Ironically, those funds target 90% of the market by number of companies given how large the small business marketplace is in the US [2].
The supply-demand imbalance for debt capital in the lower middle-market creates more favourable pricing and more conservative loan structures. Lenders can negotiate favourable terms, such as attractive entry leverage levels and stringent covenant packages. Government leverage through a longstanding public-private partnership program (discussed later) can further enhance returns.

Small Business are the Growth Engine of America – The SBIC Program Helps
Approximately 65% of job growth in the U.S. comes from small and medium-sized businesses and businesses need capital in order for this job growth to occur.
The United States’ Small Business Administration (SBA) created the Small Business Investment Company (SBIC) program in 1958 to bridge the gap between entrepreneurs’ needs for capital and traditional sources of financing.
An SBIC is a privately-owned and operated fund that makes long-term investments in US small businesses and is licensed by the SBA. The U.S. government allows up to $4 billion annually of this leverage to be made available to SBIC funds, borrowed for 10 years at a fixed rate, with no amortisation and no pre-payment fees.
Star Mountain’s partner Harry Haskins was the head career executive of the SBIC program, where he worked for 15 years overseeing a portfolio of approximately 300 SBIC funds representing around $18 billion of capital invested into U.S. lower middle-market companies. Star Mountain’s senior advisor, David Javdan, partner at Alvarez & Marsal, was the General Counsel to the Small Business Administration working with Mr. Haskins and was on the Investment Committee with him on behalf of the SBA analysing and voting on providing SBIC licenses to qualified lower middle-market fund managers.
Final Thoughts – There are Opportunities – but they Require Resources to Properly Execute
There are many high quality, established U.S. lower middle-market companies that have attractive acquisition and organic growth financing needs and opportunities. For a Business Owner, finding the right strategic partner is generally far more important than the cost of capital in order to maximise long-term valuation creation. For Investors, this is a labour intensive market to efficiently invest in and while attractive returns can be made, smaller business can require additional resources to source, underwrite, monitor and help work through challenges in order to protect capital and make an attractive return. Investors have the opportunity to make attractive returns on both a risk-adjusted and an absolute basis; however, the cost is time and resources to properly execute and manage.
About Star Mountain Capital
Chaired by Brian Finn, former Co-President of Credit Suisse First Boston and former head of Credit Suisse’s $100 billion alternative asset management business, Star Mountain Capital is a specialised asset manager focused exclusively on investing in the lower end of the U.S. middle-market. Founded in 2010 to concentrate solely on this large but inefficient market of established, growing US companies, Star Mountain is purpose-built to address the labour inefficiencies relating to sourcing, underwriting and managing investments in these smaller companies.
With a unique “Collaborative Ecosystem”, Star Mountain’s specialised business model includes investing (i) directly into high quality, growing private businesses, (ii) as a strategic fund-of-funds investor into other private equity and private credit fund managers, and (iii) as a secondary fund investor helping provide liquidity to other limited and general partners in lower middle-market funds. Star Mountain and its network of aligned portfolio partner fund managers provide companies (generally with $10 million to 150 million of annual revenues) with unparalleled flexible capital solutions, resources and relationships to grow and achieve their businesses objectives. Since inception Star Mountain has had approximately 250 companies invested through its portfolio in an aggregate basis including of its strategic fund investments.
About Brett Hickey
Brett Hickey is the Founder & CEO of Star Mountain Capital. Brett is also the Founder of the Star Mountain Charitable Foundation and has received multiple recognitions for his efforts including the Pathfinders to Peace Award alongside Morgan Freeman. Current and former memberships include Board of Governors for the Small Business Investor Alliance (SBIA); Member and former Chairman of Networks for the NYC Chapter of the Young Presidents’ Organization (YPO); Board of Harvard University Entrepreneurs Alumni Association of NY; and Board of McGill University Alumni Association of NY (recipient of the President of the Year Award).
Brett received a Bachelor of Commerce with Distinction from McGill University and graduated from Harvard Business School’s 3 year Owner/President Management Program. He is a frequent guest lecturer on industry panels and at academic institutions. Brett is also a former Canadian national gold medalist and North American medalist in speed skating. In 2017 Brett was named Future 50 CEO by SmartCEO [3].
This article is not an offer to, or solicitation of, any potential clients or investors for the provision by Star Mountain Capital, LLC of investment management, advisory or any other related services. No material discussed in this article is or should be construed as investment advice, nor is anything on this article an offer to sell, or a solicitation of an offer to buy, any security or other instrument.

Brett Hickey has been structuring, analyzing and managing private equity, mezzanine and U.S. Government sponsored investment funds for over a decade. Prior to launching Star Mountain Capital, Mr. Hickey was the Co-Founder and President of Aegis Capital Group where he ran a multi-manager platform including 4 U.S. state sponsored small business investment funds through which he made over 50 investments in small and medium-sized businesses. Mr. Hickey has extensive experience performing due diligence on, selecting and building small business fund managers and has helped structure over a dozen larger funds representing a few billion dollars in assets.

Brett can be contacted on +212.810.9044 or by email at

[2]US Census, Dunn & Bradstreet. Businesses with between $10 million and $100 million of annual revenue represents a large segment of Star Mountain’s target marketplace and Preqin.

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