David Perez and Marcos Rodriguez of Palladium Equity Partners, a New York-based investment bank for middle-market firms, see three common motives for CEOs to seek money: a transition of ownership, an acquisition, or a situation ill suited for bank financing.
Ownership transfers usually combine bank financing with equity because lenders "want to see the new owners put up a meaningful amount of capital to ensure a healthy alignment of interests," Mr. Rodriguez says. "Said another way, the banks want to make sure the new owners – or the existing owners if they want to take some money off the table – have some 'skin in the game.'"
Equity financing works better for acquisitions because of the longer-term investment horizon. In addition, besides money, the new equity partner can bring operational or strategic assets to the deal. In the final category of money-seekers are underperforming companies that need big investments to reach their potential.
"These situations are generally not well-suited for bank financing," says Mr. Rodriguez. "The risk/reward characteristics, time horizon, and lack of near-term cash generation are more appropriate for an equity investor."
To examine middle-market growth, Hispanic Business identified the top10 firms among the Fastest-Growing 100 with at least $5 million in revenues in 1999 (see table). This group shows average five-year growth of 507 percent, with Mr. Grijalva's G&A Partners leading the pack at 763.8 percent.
So far, the 10 fastest-growing middle-market companies have accessed only bank financing, based on responses to a Hispanic Business questionnaire. But nine of the 10 have written business plans, and eight have financial plans, indicating the importance of money management in running a middle-market business.
USC Professor Stancill notes that most business schools still teach what he calls "General Motors finance," resulting in managers unprepared for the challenges of running a middle-market enterprise. "Always control your cash flow, not just your cash balance," he warns. "You can't lose sight of that when running an entrepreneurial firm. In General Motors finance, you can count on big daddy [the parent corporation] to feed more money down the pipe. And they [middle market entrepreneurs] tend not to worry about it until they're short on money."
Middle-market CEOs also feel a squeeze on the operations side. Mr. Grijalva cites the dilemma of "bringing in professionals who can help your company to the next level and at the same time recognizing and rewarding the people who brought you to where you are. Often these two objectives conflict because of the expectation gap. Developing an administrative and operational infrastructure that takes into account your current customer base and future growth also presents challenges." The HR service industry depends on a company's ability to handle a huge number of small transactions, so automation and communications technology become key growth factors.
In contrast, Mr. Gilbert faces the task of bidding for ever-larger contracts on federal construction projects. "The government has bundled much of their construction work into multiple award contracts, and to win those contracts you have to develop a different kind of proposal," he says. "We set out to become not only proficient but also expert at doing just that."
Besides CEOs, economic development experts and public policy-makers have a keen interest in growing the middle market. Historically, government agencies have focused on helping small businesses through loans and seminars, with recent efforts focused on micro-enterprise. But a new strategic direction at the Commerce Department's Minority Business Development Agency (MBDA) specifically helps companies move into the middle market. According to MBDA's new mission statement, 'it is critical to promote medium to large business enterprises that can have a significant impact on employment and the tax base in their communities."
Ramesh Swamy, director of the MBDA-funded Los Angeles Metro Minority Business Development Center, looks for companies with at least $500,000 in revenues and two years in business. "We are looking at moving companies from six figures to a big seven figures," he says. "We are looking at companies that can really make an impact."
To help companies reach the middle market, Mr. Swamy assembles teams of experts that focus on operations, financial control, and marketing. Team members have backgrounds in consulting with firms like Booz Allen Hamilton and Ernst & Young, and Citibank participates on financing. "This team approach hasn't been done in this space before," says Mr. Swamy, noting that other agencies stick with one-on-one counseling. "But as the company grows, the problems grow more complex, and one-on-one won't solve them."
The impact of the program is measured by jobs created and capital accessed. Middle- market firms offer better prospects for both compared to smaller businesses. "Politicians should take an interest in this [middle market]," says Mr. Stancill. "One reason for the interest is that the biggest employers of minorities are other minorities, so if we develop minority businesses, we can sop up a lot of unemployment among Hispanics and blacks."
Tesoro Corp.'s Mr. Gilbert has his own recipe for growing a middle-market company. It starts with 10 percent spent identifying the right market niche, followed by 10 percent hard work and another 10 percent in getting good advice. Then 60 percent comes from hiring and partnering with the right people.
The final 10 percent is luck. "Tesoro has been in the right place, with the right people, with the right contract, with the right subcontractor, with the right agency many times," Mr. Gilbert says. "Each time luck was involved but, of course, having identified the market niche, having worked hard to prepare well, having the right people with the right talents and experience – all of that allowed luck to make the company grow."
View the Top 10 Mid-Size* Companies by Percentage Growth
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