The lower middle market is the lower end of the middle market segment of the economy, measured in terms of companies’ annual revenues. Companies with annual revenues in the range of $5 million to $50 million are grouped in the lower middle market category.
These companies are classified just above small and medium-sized enterprises (SMEs) or Main Street companies with less than $5 million in revenues.
Lower middle market companies play an essential role in the national and global economy. The purchase of one company by another (acquisition) or merging two companies into a larger one (merger) is one of the most common ways to gain size and competitiveness today.
Generally, this type of business operation is triggered by identifying a threat or an opportunity in the market. The classification helps investors weigh the high growth potential of the category against the risk involved to arrive at reasonable valuations.
Middle market companies are further classified as:
- Lower middle market
- Medium middle market
- Upper middle market
While the commonly used criterion for this classification is annual revenue, other metrics, such as the number of employees and tangible capital assets employed, may be more appropriate in many cases.
With more companies to invest in, more significant opportunities for business improvement, and lower valuations and barriers to entry, lower middle market mergers and acquisitions are attractive to much private equity (PE) firms and strategic acquirers. In addition, lower middle market mergers and acquisitions are more minor, less risky, and require less debt, which means that demand continues to grow these days.
Mergers involve the joining or integration of two companies to form a new and distinct third company, but which is essentially a combination of the two merging organizations. Although mergers are ideally conceived as an equal integration, it is usual that one of the companies acquires greater relevance in practice in practice.
On the other hand, the acquisition is the partial or total purchase of a company with a predominance of one of the companies over the other according to the terms of the agreement, in which aspects such as economic, logistic, or technological contributions are considered.
Both operations have the objective of gaining dimension, scope, capital and thus take advantage of opportunities, achieve leadership in the market, or face potential threats.
Depending on the relationship between the participants in the merger or acquisition of companies, the operation can be classified as follows:
- Horizontal integration occurs when there is a relationship between competing companies, i.e., those belonging to the same sector and industry.
- Vertical integration. This occurs when companies operating at different stages of the production process, such as development, production, or distribution, seek to create more complete chains within the production cycle by consolidating their operations.
- A conglomerate is the integration of entities operating in different branches of industry (pure integration) or indifferent product lines or markets (mixed integration).
Companies in the lower middle, which are likely to become part of the upper segment, generally command a valuation premium. The ranking, therefore, helps the healthy development of a divestment market.
Many potential buyers seek acquisition targets in the lower middle market because valuation multiples tend to be lower. In addition, buyers of experienced companies can more easily obtain operational improvements in lower middle-market companies.
