The small American SME market: poorly covered and ready to grow?

The US private debt market is a good diversification tool for investors willing to accept its illiquidity.

By Michael R. Smith, co-head of US private debt

The US private debt market is well established, having emerged in the 1950s following the creation of the SBIC program (Small business investment firm), by the United States Congress. Since then, continued tightening of bank lending regulations has driven asset class growth. With around 200,000 companies, the SMB market in the United States now offers a sizeable array of investment opportunities.[1]

We believe that the increasingly stringent regulatory environment is leading to fewer funding opportunities for these companies and that private lenders are now taking action to fill this gap. However, in our view, most private lenders focus on private equity funded transactions or large corporate financing. This creates an opportunity for lenders who focus on complex, unsponsored opportunities or special situations in the smaller SME market.

The small SME market (companies with EBITDA between $ 5 million and $ 25 million) has historically enjoyed a performance premium of around 200 basis points over the traditional SME market (Fig. 1), as well as a profile of lower debt.[2] We therefore believe that the combination of lower leverage and higher rates of return creates an attractive dynamic for investors.

Figure. 1 The small SME market offers better returns than the main SME market
Source: “Middle Market Leverage Cash Flow Market at a Glance” – SPP – January 1, 2015 to June 30, 2022.

Constant flow of offers, guide to growth, realization of value

The small SME market is poorly covered and yet can offer a wide range of potential opportunities for private lenders across a whole range of businesses. In particular for: (I) teams of

entrepreneurial management / investors (e.g. independent sponsors and family offices) wishing to acquire / consolidate a business; (ii) family businesses that consider investing in larger structures; (iii) joint stock company called “micro caps»With specific capital needs and limited access to growth capital. The entrepreneurial spirit within the small SME market is omnipresent and constitutes a continuous reservoir of interesting opportunities.

However, investing in these companies still requires access to a wide range of procurement channels. Given the size of the investment universe, it is essential to pay close attention to fundamental research before making any investment decisions, but also to monitor and manage risks afterwards, in order to ensure good protection against the risk of a portfolio decline. definitely.

There are fewer lenders in this market as traditional players may consider these assets to be more risky. However, we believe these companies have good upside potential due to the significant impact of even modest growth initiatives and broader acquisition prospects. The segment of family businesses and businesses owned by their founders, for example, is less competitive and can therefore offer higher returns with less leverage. Additionally, independent sponsors who can demonstrate targeted execution and / or support from their portfolio companies tend to gain preferential access and more attractive purchase price multiples for potential investments.

In terms of investment instruments, US private lenders have several options that largely reflect broader European and US operations: senior / unitranche, mezzanine, preferred stock and common stock or a combination of debt and equity.

Public markets are affected by pressure on rates and high levels of volatility. Therefore, we believe this is a good time to consider a US private debt allocation as a diversification tool; floating rate loans offer protection against rising interest rates and limited volatility in terms of mark-to-market. The embedded illiquidity premium can enhance the performance of the portfolio.

Muzinich & Co. mentioned herein is defined as Muzinich & Co., Inc. and its affiliates. This material has been produced for informational purposes only and as such the opinions contained therein should not be construed as investment advice. Opinions are as of the date of publication and are subject to change without notice or notice. Past performance is not a reliable indicator of current or future results and should not be the only factor to consider when selecting a product or strategy. The value of investments and the income from them can go down as well as up and are not guaranteed. Exchange rates can cause the value of investments to rise or fall. Emerging markets can be riskier than more developed markets for a variety of reasons, including but not limited to greater political, social and economic instability, greater price volatility and reduced market liquidity.

All research contained herein has been obtained and may have been used by Muzinich for his own purposes. The results of this research are made available for informational purposes and no guarantee is given as to their accuracy. Opinions and statements on the performance of financial markets that are based on market conditions constitute our judgment and such judgment may prove to be incorrect. The views and opinions expressed should not be construed as an offer to buy or sell or an invitation to engage in any investment activity, but are intended for informational purposes only.

Issued in the European Union by Muzinich & Co. (Ireland) Limited, which is authorized and regulated by the Central Bank of Ireland. Issued in Switzerland by Muzinich & Co. (Switzerland) AG. Registered in Switzerland under the number CHE-389.422.108. Headquarters address: Tödistrasse 5, 8002 Zurich, Switzerland. 2022-05-04-8512

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