Over the past few months I’ve witnessed dozens of violations to middle market finance. If you don’t know what that is, you haven’t read my textbook, Private Capital Markets. And chances are good that you are one of the people making a fool of yourself in the middle market.
I’ll use this Moment to summarize the 640 page behemoth.
- Public and private capital markets are not substitutes. This is a major deal and overturns 30+ years of academic doctrine. These markets differ in most important aspects, such as: risk and return are unique to each market; liquidity within each market is different; motives of private owners are different from those of professional managers; underlying capital market theories that explain the behavior of players in each market are different; private companies are priced at a point in time, while public companies are continuously priced; public markets allow ready access to capital, while private capital is difficult to arrange…just to name a few of the differences.
- Capital markets are segmented, meaning that small, lower middle market, middle middle market, upper middle market, and large companies have unique costs of capital, differentiated behavior of players in the segment, and correlated valuation metrics
- The book introduces a new field called “middle market finance,” the study of how managers of middle market private companies make investment and financing decisions
- Middle market finance theory – also created in the book – is a holistic theory that shows how business valuation, capital formation, and transfer are inter-related and interconnected
- Value relativity reigns supreme in the private markets. This means that private business valuation is relative to the reason one needs to know the value. Another way of saying this is that a private business value is relative to the value world in which it is viewed. Reasons select value worlds. Each value world yields a unique value. There are dozens of reasons why a private business value needs to be determined; thus, there are dozens of value worlds.
- Private capital is allocated via the rules of a flea market, as opposed to the supermarket of securities enjoyed by large public companies. The private bazaar does have structure, however, as capital providers organize themselves based on risk/return goals.
For this first time in history, the private capital markets have been thoroughly surveyed, as yours truly partnered with Pepperdine University to conduct the Pepperdine Private Capital Market surveys. The Pepperdine Private Capital Market Line depicts an empirical cost of capital line for the middle market.
- Private business transfer comprises all possible ways to transfer a private business interest. Transfer channels and methods are organized as the Business Ownership Transfer Spectrum. PCMs 1 introduced this spectrum, which provides the structure for Exit Planning.
- Transfer methods select value worlds! This means that once an owner decides how to transfer part or all of the business, he/she has (usually unknowingly) chosen the value as well. This last bullet is aimed at all of the so-called exit planners who think all transfer methods are valued using the same methodology. You should be sued for your ignorance, and I will gladly (and freely) give of my time to help biz owners get legal satisfaction.
One of the most important contributions of the book is the further description of the Private Cost of Capital (PCOC) model. John Paglia at Pepperdine and I created this new discount rate model. PCOC redefines risk in an empirical and highly useful way.
So if you are out there presenting yourself as an expert in valuation, capital raising or transfer advisory, and you haven’t read PCMs, you are most likely clueless and a danger to yourself and your clients.