A Mid-Year Pulse Check on U.S. Middle Market Private Equity: Insights from the 2024 Chicago Private Equity Forum

In a volatile environment for Private Equity, the middle market has shown remarkable resilience. According to Pitchbook data, in 2023 middle-market PE only dropped by 19%, while overall deal values declined 33%. Interestingly, middle-market deal counts increased by 4%, capturing nearly 70% of all PE deals last year. This trend reflects the resilience of the underlying businesses, which account for two thirds of net jobs created over the last 25 years and created over 2 million jobs during the great financial crisis, when large corporates lost nearly double that.

The Primacy of Operational Value Creation

Buyouts, like our overall economy, are adapting to new realities, driven by higher interest rates and economic uncertainties. Operational improvements are increasingly the primary source of value creation, overtaking traditional methods like financial engineering and leverage.

An operational value creation strategy can provide a natural checkpoint for alignment on future growth between management and the new owners.? At the other end of the spectrum, in financial turnaround situations, recent anecdotal evidence suggests over two-thirds of value creation can come from operational initiatives.??Among the potential levers, two stand out in our recent experience at Brightstar Capital Partners.

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Key Operational Levers: Digitization and Strategic Finance

Digitization today is a critical lever for middle-market businesses. Many companies still operate on outdated digital infrastructures, inadequate for their current or aspirational scale. Implementing robust accounting systems, CRMs, and KPI dashboards is essential. More recently, firms have explored practical AI applications, such as using AI tools to optimize contract pipelines and target the right RFPs.

Strengthening the finance function is another priority. Middle-market companies sometimes start with a CFO who functions more like a controller. To support business growth, these companies benefit from strategic CFOs capable of comprehensive financial planning, budgeting and analysis.??The CFO also should be a team builder that can develop and hire a strong bench.

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Optimizing Third-Party Relationships

Middle-market companies frequently rely on partnerships and outsourcing to maintain variable capacity without burdening their P&L with fixed costs. The strategy is straightforward: retain competitive advantages in-house and outsource non-core functions. For instance, many firms use third-party utilities for non-core processes but retain control over critical data and analytics.? For middle market private equity firms that help their companies choose consultants, it is important to choose ones that don’t rely on change management frameworks designed for large corporates.??Those frameworks usually don’t translate well to the hands-on, informal culture of middle market firms, particularly those that are founder- or family-owned.

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Preparing for Exits: The Importance of Proven Value Creation

In a market with sophisticated buyers, potential buyers often will only pay for tangible value creation, not unproven potential.??When a business model transition isn’t yet complete, demonstrating successful value creation through pilots and proof-of-concepts is crucial.??In one of our recently exited portfolio companies, we hadn’t fully completed the transition from transactional sales revenue to recurring service revenue.??This created an opportunity for the buyer of the business to capture further upside during their ownership — but they only got comfortable with the EBITDA projections by seeing and verifying the successes to date.

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In conclusion, even in a volatile market environment, the middle market continues to be fertile ground for private equity.??The universe of target companies runs in the tens of thousands in the U.S. alone.??Value is increasingly driven by operational value creation and strategic growth — and by creating stronger companies, private equity owners can contribute to a stronger economy.