In this low interest rate environment, the search for yield is sending investors of all stripes to far flung places and uncharted territories looking for a decent return. These days, a “decent” return implies the investor has uncovered some form of magical alchemy that has enabled him or her to not only beat the market, but to serve as an early funding source of the next big thing.

Sadly, this investment reality is as rare as it sounds.

Instead, the broad investment environment looks rather stagnant as if it is operating by rote principles calling for reasonable prudence in these heady times. In the era of cheap money (financial hyperhidrosis, if you will), a flight to quality and low interest rates is neither the top of the economic pyramid that should draw investor attention nor the bottom, replete with legions of entrepreneurs each with the next big thing. Rather, the real investor Promised Land lies in the hum drum world in the middle.

Mid-market firms rarely attract headline news. They cannot easily raise capital by divesting non-core assets, issuing bonds or going public. There are no proverbial barbarians at the gate with oodles of money ready to invest. The overall illiquidity of this market is used as a warning sign by the SEC that investors should steer clear of private placements, lest they favor investments without an exit.

These firms, however, often offer revenue predictability and stable returns that are subject to a “managerial leverage effect” that is difficult or impossible to replicate in their larger and smaller brethren. SMEs, in a nutshell, are good investments, yet the difficulty in raising patient capital in this space is troubling and betrays a general investor disinterest and an irrational risk aversion.

Funneling growth capital into the 'missing middle' can give the economy a jolt and unlock massive potential, company investment and hiring.

Add the diseconomy of scale that is hampering large investors from capitalizing on the middle market and one will see why many large investors are entering negative yield investments. In short, investment guidelines are so restrictive among many large funds, that a knowingly bad investment is now considered the best of the worst alternatives and a form of risk premium against an increasingly uncertain world.

The mortality rate plaguing startups should reasonably chasten untrained investors, who are likely to get burned early and often looking for the next Uber. Yet, this market is rife with funding sources and innovation. From the revolution in peer-to-peer finance that is upending entire business models and threatens the very viability of brick and mortar banking, to perfectly diversified portfolios of startups, bottom of the pyramid capital is experiencing a veritable renaissance.

Consequently, many of the firms powering this capital awakening are themselves becoming massive and public. SoFi, a social financial intermediary, raised $200 million in an IPO valuing the firm at $1.3 billion. It would seem we are entering a veritable "standards war" on which the social capital model will prevail. Whichever democratized funding model wins, to the entrepreneur go the spoils.

There is reason to be concerned, however, about the state of entrepreneurship and the peril in training an entire generation of risk-takers how to build businesses they can fund, as opposed to businesses they want to run based on some intrinsic value proposition. Serial entrepreneurs sport the logos of businesses they have shepherded through the ideation-creation-exit lifecycle like a Scout wears merit badges.

In The Spotlight

Surely the impossibility of this feat is deserving of praise. Yet, in terms of long term value creation, the "one trick" of an Apple would be the type of investment you would hold in your portfolio.

The real challenge here is not so much with the state of entrepreneurs, without whom no vibrant economy could persevere. The trouble lies with investors who are imposing a myopic short-termism on the startup economy, as if all business was measured in a 3 to 5 year investment horizon, delivering 20 percent returns in that time. Not surprisingly, the average startup pitch deck makes these predictable promises, which statistically so few deliver. At 3 to 5 years, the fun begins and real value creation ensues.

The middle market, on the other hand, is full of businesses that have defied the force of startup gravity and some are on their inexorable march to a public offering. Many more are consigned to being perpetuities delivering average returns. In this environment, 1 basis point above prime is a good investment. Combined with a long investment horizon, funneling growth capital into the so called 'missing middle' can not only give the economy a jolt, it can unlock massive potential, company investment and hiring.

The real challenge in middle market investing lies not in the opportunities in these firms, although the market labors from opacity. Rather, it lies in the egos and excessive valuations that plague many owner-operators. Many of these firms are family held and believe that any dilution of equity comes with a dilution of power. This often results in a flight of the very intellectual capital that keeps these firms viable. As investors continue their search for yield in exotic locations of the economy, look to the middle where a little can go a long way.


Dante Disparte
About The Author Dante Disparte
Dante A. Disparte is the founder and CEO of Risk Cooperative. He chairs the Business Council for American Security with the American Security Project and is the chair of the Harvard Business School Club of Washington, D.C.

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