Middle Market 2Q 2023 | Private Equity Report
Performance Highlights and Market Shifts
The second quarter of 2023 presented a complex landscape for middle market private equity (PE) transactions. Defined by deal sizes ranging from $10 million to $1 billion, the middle market comprises the Lower Middle Market (LMM), Core Middle Market (CMM), and Upper Middle Market (UMM). Despite economic headwinds, the middle market continued to show robust performance, outpacing larger funds with a significant performance advantage over the past quarters.
US middle market funds, sized between $100 million and $5 billion, maintained their edge over mega funds, reflecting a median one-year horizon return gap of 9.7%, the widest since 2016. Even though the performance advantage narrowed slightly in 1Q 2023, it remains strong at 5.2%, underscoring the resilience of middle market investments against larger, more volatile funds.
Economic Environment and Investment Strategies
The broader economic environment in the US showed modest real GDP growth between 2.0% and 2.4% in the first half of 2023. Inflation, although beginning to wane, persisted longer than expected, influenced by falling energy prices and fluctuating core goods and services inflation. High borrowing costs and increased lender caution following early 2023 bank failures created hurdles for quick and efficient deal closures. This cautious climate shifted PE focus towards smaller, more manageable deals in the middle market, where debt financing remains more accessible.
With over $1.1 trillion in dry powder reserves, PE firms are poised to explore creative capital deployment strategies, including minority investments and private debt placements, to navigate the challenging economic conditions. Despite a slow start in larger buyouts, middle market PE firms are actively adjusting to leverage emerging opportunities in this evolving landscape.
Future Outlook and Strategic Middle Market Implications
Looking ahead, the middle market is set to capitalize on its momentum as PE firms adapt to high interest rates and valuation pressures. Average EBITDA multiples saw a slight contraction, reflecting a more favorable bid-ask spread for buyers. This trend, combined with a strong share of buyouts and stable deal flow, positions the middle market as a pivotal area for investment. Investors and fund managers must continue to adapt to changing economic signals while seeking high-quality assets with long-term growth potential.