The lower middle market (LMM) is a distinct market segment with unique characteristics. But it's not that well understood and this lack of understanding means that companies in this segment often don't get the level of attention and help they need. There are a lot of owners and managers of lower middle market companies out there who feel alone. That’s a problem for them but also for the greater community because these companies play an important role in their local economies and beyond.
By highlighting and learning about these characteristics, we believe that we can collectively do a better job of serving this market. This post addresses seven unique characteristics of this market. We’ve seen over the years that by helping advisors connect with and learn from each other, local companies get better outcomes. A summary video of a web program hosted by XPX on the subject is above. I highly recommend the full version of the program including input from the XPX community.
So let’s dig in.
The most common data set for the total number of businesses in the US comes from the US Census. This data distinguishes companies by the number of their employees. Using this data, we see that there are about half a million companies with 20-100 employees which represents roughly 2% of the 30 MM companies in the US.
But in today’s tech-intensive world, there are big differences in the employee base of companies by industry. So at XPX, we usually define the US lower middle market by revenues as companies with $2.5MM to $100 MM in annual sales. Data published using the North American Industry Classification System by the NAICS Association identifies roughly 531,000 companies in the $2.5-100MM sales range.
Although this range isn’t set in stone, this revenue range is a good starting point for identifying the lower middle market.
The data on company numbers gets even more interesting when you look at data on corporate survival rates from the US Bureau of Labor Statistics. They have an amazing graph (see video for the illustration) that shows business survival rates of companies started in 1994-2015. The curve is almost exactly the same for every year and shows that consistently 50% of businesses don’t make it past five years. And that only 20% make it to 20 years.
Companies in the lower middle market are past the start-up stage. They are scaling and growing. But they do not achieve (or often seek) the hyper growth of a public company. They truly are in the middle. Which doesn’t diminish the accomplishment.
The size data make it clear that companies in the LMM have worked hard to get there. Very few do make it. That means that they’ve developed a sound offering and business model. They’ve been able to scale it to a meaningful level. And many are able to thrive for decades. In fact, the average age of the companies in a recent analysis of the fastest growing middle market companies by the National Center for Middle Market at Ohio State was 40 years. Many middle market companies are here to stay.
As the data show, it’s not easy to get into the lower middle market. And once you get there, survival is not assured. The LMM is when you create a company. . Josh Patrick, a prolific writer about this market puts it this way: “The lower middle market is where business becomes more complex.”
At this point, management systems and technology, financial, compliance and human resources management all become more important. Testing the business model and market demand and creating a scalable company to meet that demand. And that’s just the beginning.
The Corporate Finance Institute describes this stage as when an entrepreneur “becomes a manager and learns how to manage managers.” This is all different from the talents and knowledge that got the entrepreneur to this point. Now they also need management skills. A great source on the issues at different growth stages can be found in No Man's Land by Doug Tatum (in a discussion with XPX Members, I learned that he's in the process of updating the book).
All these challenges are part of why so many entrepreneurs and their advisors really love working with companies at this stage. There’s a chance to really make your mark and see the effect of your efforts. At this level, business is still very personal.
The personal connection carries through to ownership. Almost all businesses in the lower middle market are private, often owned by the original founders.
Private ownership can be much more flexible than the scrutiny and cost of the public markets. But it’s not without complication. In the LMM, the owner and the manager is often the same person. As the company increases in value, it becomes a greater and greater percentage of the owners’ net worth. On the business side, this puts a burden of risk management on the owners. On the personal side, they need to consider shareholder agreements, life insurance, trust, estate and tax planning
Owners of businesses in the LMM end up wearing many hats reflecting their role as equity, management and many day-to-day roles in the operation of the company.
The primacy of owner-managers means that the future of the lower middle market company is tied to specific people. People don’t have infinite lives. Companies can have a longer life than their founders. But to pull this off, to maximize the value of a LMM company and ensure its longevity, its owners have to think about transition strategies (see some great videos of owners discussing these challenges). Because of the many hats the owner wears, there has to be a strategy at many levels. What happens to the ownership but also what happens to the company? Answering these questions is key to transition.
There are at least three major segments in this journey: business value growth, business value transfer and owner life and legacy. Ideally, an entrepreneur will have a plan on all three levels. But this isn’t easy to do alone. That’s why LMM companies and their owners should have support from strong ecosystems. However, these ecosystems aren’t always there for them
Startup, innovation, entrepreneurship have received a lot of (deserved) focus in recent decades. There are countless opportunities for taking classes, finding networks, funding and support for early-stage businesses in many regions of the US. But, as we saw in the survival data, early stage companies don’t all make it. And once they do get to a sustainable point, the startup ecosystem doesn’t really serve their needs anymore.
On the large corporate side, there isn’t a single clear ecosystem per se. They’re big and serving them is big business. The fact that many are public also brings in the discipline of the public equity markets and/or large, more sophisticated investors.
But then, as we’ve seen above, there’s the middle. On the low end, there is some overlap with the startup ecosystem. And at the high end, there is some overlap with the large corporate ecosystem. But the companies in the middle don’t have as focused an ecosystem.
What do the ecosystems for look like for the lower middle market? They are usually local or regional. Companies get their help through more traditional networks like industry associations and Chambers of Commerce. But there usually aren’t local communities optimized to the needs of the LMM company. Yet, we’ve seen that the size, growth challenges, private ownership and need for transition planning add up to unique needs of this segment. In our experience, these needs are usually met by a group of trusted advisors.
Who are these advisors? There are at least a dozen different professions that support companies in the lower middle market along this journey.
Advisors from these professions often have an outsized role for all the reasons described above. The survival and growth challenges. The complications of private ownership. The need for specialized knowledge related to transition strategies. And the fact that management structures are still being developed and are not as robust as larger companies. The first managers in key support roles may not have the level of experience or exposure they need to fully handle topics like tax, finance, HR, strategy and systems. So they turn to outside advisors. But expertise is not enough.
While most advisors are expert in their field, their advice can work at cross purposes if they fail to work in a coordinated way with others on the company’s team. This can be compounded if they lack exposure to the unique issues of this market segment. This is logical on one level—business schools don’t have specialized curriculum for the LMM (so much of management theory is still dominated by the large, public company perspective). If advisors don’t understand the LMM and don’t play well with others, they can further complicate their clients’ already considerable challenges.
For this reason, a collaborative approach is the number one principle of good advisors that we’ve seen in this market. Advisors can ensure that their results are maximized by doing the work upfront to learn about the roles and perspectives of other professions. And to build a network of people in these professions that they know and trust. A strong ecosystem builds better advisors and supports stronger outcomes in lower middle market companies.
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