In a recent study, the National Center for the Middle Market and the Milken Institute explored near-term expansion plans for middle-market businesses, how the companies plan to fund growth, and how their attitudes toward financing compare to small businesses.
While middle-market firms are more likely than small businesses to expect growth—nearly all middle-market companies plan on expansion over the next 12 months—the majority of firms do not anticipate taking on additional debt to achieve their goals. In fact, like small businesses, middle-market companies maintain a notably conservative attitude about debt. Rather than viewing debt as a tool for growth, most are reluctant to borrow unless it becomes necessary. Middle-market firms are more likely than small businesses to see value in carrying some level of debt, but many prefer low debt levels.
Key findings from the study include:
- Cash is king. Most middle-market firms plan to use cash on hand to fund expansion and new projects in the coming year. They are significantly more likely than small businesses to rely on cash, and upper middle-market firms (with revenue of $100 million to $1 billion) are the biggest proponents of paying as they go, with 70 percent planning to finance growth with existing resources.
- Only about two in 10 small and midsize businesses plan to take ondebt to finance growth. However, core middle-market firms (with revenue of $50 million to $100 million) are the most likely to borrow; 30 percent indicate that they will use debt to grow.
- Low debt levels are preferred. Middle market firms have more tolerance for debt than small businesses, but they still target low debt-to-asset ratios. About 60 percent of middle-market executives say that a 20 percent debt-to-asset ratio is right for their businesses. And some— about 20 percent of core and upper middle-market firms and a quarter of lower middle-market firms—prefer no debt at all.
- Bank debt is the most common type of existing debt for middle-market firms. However, about 40 percent of core middle-market firms also carry other private debt.
- Middle-market companies borrow when they need to. Around half of middle-market firms strategically plan for borrowing needs, and they are more likely than small businesses to take a top-down approach to managing debt. For middle-market companies, current debt levels are most often the result of past decisions to borrow when needed.
- Borrowing costs could impact plans. While the majority of small businesses and middle-market firms would not change expansion plans based on the cost of capital, core middle-market firms are most likely to be impacted by an interest rate swing. About six in 10 core middle-market firms say a rate change could cancel, slow or reduce investments. A two percentage-point increase is seen as the tipping point.
- Traditional bank loans are the most popular funding source for middlemarket companies. Bank loans are also the source of capital most likely to be considered for future funding. About three-quarters of middle-market firms cite strong relationships with bankers as a driving factor in this preference.
- Private equity is a distant second to bank loans. About half of middlemarket firms are familiar with private equity as a source of capital and are much more likely to consider it than small businesses. For core middlemarket firms, private equity is the second leading source of capital, but only 14 percent of core firms have used this option over the past three years. About 15 percent of middle-market firms say they would consider private equity.
- Whether borrowing from a bank or another source, middle-market firms say the interest rate has the largest impact on their decision. They also value ease of access, certainty of execution and speed of execution.
//The National Center for the Middle Market is a collaboration between GE Capital and The Ohio State University Fisher College of Business.