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BPM’s Nick Steiner Featured in the San Francisco Business Times

This article originally appeared in the San Francisco Business Times on August 21, 2020.  

In many ways, the Bay Area’s middle market companies are a testament to the region’s business diversity. Among its ranks are some of the country’s fastest-growing innovators, galloping ahead on Wall Street, while others are workhorses chalking up steady growth, often outside the limelight. 

Still, middle market companies find themselves squeezed between the vaunted Fortune 500 behemoths and the mom-and-pop small businesses of Main Street. That leads to distinct disadvantages. Don’t go to Washington looking for a middle market counterpart to the Small Business Administration or the Fortune 500’s powerful lobbyists on K Street. 

The middle market universe, broadly defined as companies with annual revenue between $10 million and $1 billion, covers a broad spectrum of industries that include public and privately held companies as well as family-owned businesses, partnerships and sole proprietorships.  

While the middle market accounts for only around 3% of U.S. companies, this slice of American business is responsible for one-third of private sector jobs and economic activity, according to the National Center for the Middle Market, located at Ohio State University.  

“Back of the envelope calculations by us show that from the Great Recession to the Great Pandemic, middle market companies accounted for 60% of net new jobs,” said Thomas Stewart, executive director of the National Center for the Middle Market. “The middle market is a huge, undercovered area.” 

The middle market is estimated to employ 30 million people nationwide with combined annual revenue of $10 trillion. Fueling all that growth means middle market companies operate at a robust pace when it comes to hiring, leasing and financing it all. Partially in response to barriers faced by middle market companies, the sector has fostered its own cottage industry of professionals and service providers catering to its financial, accounting and business needs 

A key storyline for the middle market in the current crisis has been the acceleration of digital transformation. Long positioned as an eventual goal, the situation posed by the pandemic has underscored the necessity of a new embrace of technology.  

The New Reality 

The Bay Area’s middle market ranges not only in size and sector but also in how some are thriving and others are diving amid the pandemic. One only needs to take a look at Wall Street for evidence of a clear-cut divide.  

DocuSign has seen its shares soar about seven times higher since top-tier bankers Morgan Stanley and JPMorgan Chase took the San Francisco electronic-signature company public in April 2018. DocuSign posted revenue of $701 million in 2019, and the company saw revenue jump to $297 million in the three-month period that ended April 30, 2020 — up almost 40% from the same period a year ago. 

Meanwhile, lesser known Hayward-based Italian wholesale food distributor Armanino Foods of Distinction — with revenue last year of about $43 million – has seen its thinly traded shares fall more than one-third this year. Armanino Foods has trimmed its dividend as it copes with many of its restaurant customers being closed amid shelter-in-place orders. But the company is seeing a recent pickup in sales for its pasta and sauces. 

“We experienced a steady increase in sales and margins since the lowest point of the pandemic in early April, particularly in the domestic market. This upward trend continued through the end of the quarter,” Tim Anderson, Armanino Foods’ president and CEO, said in announcing second-quarter results. “The economy, trends and consumer behaviors are still relatively unknown and will take several quarters to truly understand how this pandemic will affect our existing business model going forward. 

“That being said, we believe we are well positioned financially from a balance sheet perspective to weather the storm and strategically invest,” Anderson said. 

Both DocuSign and Armanino Foods are examples of how the pandemic-induced economic downturn has spurred middle market companies to set aside initial plans and projections in place before much of the economy shut down as they adapt to the new realities of business. And, they underscore how a divide in strategy can easily separate winners and losers in this market.  

“Covid-19’s impact on the economy has been particularly disabling for the middle market, with smaller midsize companies bearing the brunt of the pressure,” according to accounting firm RSM US LLC, citing a second-quarter survey for its RSM US Middle Market Business Index. “Smaller middle market businesses sought lending relief at significantly higher rates than their larger counterparts and appeared less able to shift to remote work.” 

In the National Center for the Middle Market’s breakdown of the most important factors for middle market companies to ignite growth, “investing and innovating” are listed as key to “being able to withstand a downturn in your industry.”  

In the research center’s parlance, these companies are “innovators,” which focus on developing new products and services and processes for delivering them. 

Today’s work-from-home environment, in which as much as possible is handled electronically, has fueled DocuSign’s business that allows documents to be signed electronically.  

Enabling the digital transformation of other companies has been a bright spot for the middle market. Companies like DocuSign and Slack have created the tools and products that are a key enabler of the new way business is conducted due to Covid-19. 

“DocuSign is in the business of helping customers digitally transform their agreement processes,” said Kirsten Wolberg, DocuSign’s chief technology and operations officer. “Of our customers, about 60% have been focused on digitally transforming their front-office functions like sales, marketing and customer service. Another 40% of our customers are focused on transforming back-office functions like finance, IT, HR, legal and procurement.” 

Office closures and working from home amid Covid-19 spurred companies to rapidly embrace digital transformation, adopt new communication tools and shift more operations onto the cloud. 

“Within DocuSign, we already have the tools for remote collaboration, like Slack and Zoom, and our operations were designed with remote work in mind,” Wolberg said. “We also highly leverage our own solutions.” 

At Zendesk, the pandemic rapidly altered consumer demands and appetites for the San Francisco cloud-based customer service company’s products.  

“Covid-19 caused a massive shift across all industries and customer expectations have changed dramatically within a matter of weeks,” said Colleen Berube, chief information officer and senior vice president of operations at Zendesk. 

The company reoriented its focus to services in greater demand, “prioritizing the things that have the highest degree of customer impact, and rolling out the tools that are easiest to use and have the capability to deliver results fast,” Berube said.  

That focus on quick results amid the pandemic may explain why the digital transformation of business operations is moving full speed ahead despite economic uncertainty caused by Covid-19, according to a survey of middle market companies by the National Center for the Middle Market. 

An Umpqua Bank survey released this month found more than 80% of middle market companies have already begun automating or plan to automate tasks previously performed by workers.  

Deal or No Deal 

Other growth channels for the middle market appear to currently be in a lull. On the M&A front, there was a notable deal this month in which private equity firm Thoma Bravo cut an $11 billion cash-and-stock deal to sell Pleasanton fintech Ellie Mae, which provides a cloud-based loan origination platform for the mortgage industry. 

Ellie Mae, which is No. 36 on the San Francisco Business Times Middle Market 50 List, was snapped up by Intercontinental Exchange, owner of the New York Stock Exchange. Intercontinental Exchange saw its shares change hands at a record price shortly after announcing the Ellie Mae acquisition. 

Such a deal doesn’t come as a surprise to Nick Steiner, partner in San Francisco accounting firm BPM. Still, he added that the deal isn’t necessarily indicative of the market as a whole.  

“We have had a number of clients get acquired, especially in the technology space. All of the big tech companies, with their stock where they are and all their resources, have been very acquisitive,” Steiner said. “We’re not seeing a lot of our middle market clients acquiring a lot of other companies. That’s been pretty quiet all of 2020.” 

Today’s M&A financing environment is very favorable to the nation’s top tech companies, with high stock prices providing a powerful currency for stock-swap deals. Historically low interest rates have also made financing all-cash deals easier. 

Asked why middle market companies aren’t out shopping, Steiner said the sector is largely taking a cautious approach. 

“No one knows what the next six months has in store,” Steiner said. “There are a lot of people out there waiting for the other shoe to drop.” 

But some observers are saying middle market companies are starting to move off the sidelines. 

“There are trillions of dollars in investment dry powder with corporates and private equities that are constantly searching for deals,” said Kartik Sundar Raj, a partner with accounting firm RSM US in San Francisco. “The middle market has become a rich target.” 

Others Also See the Pickup in Activity. 

“M&A activity in the middle market came to a full stop in March and April and now is starting to accelerate rapidly, which is tracking some of the larger company M&A activity that picked up sharply in the last 30 days,” said longtime San Francisco banker Jon Merriman, who is now chief business officer at B. Riley FBR in Los Angeles.  

Merriman said the sector’s lack of operational visibility led to the slowdown in deal flow, but executives are getting increasingly comfortable with future projections. 

“We saw several of our sell side companies take two to three months to calibrate their financials, fully stopping a prospective M&A process, given their uncertainty. That period has normalized,” Merriman said. “Given the huge amount of liquidity in the market from the Fed, valuations of private companies are expanding, and obviously the public equity markets have hugely benefited from the massive liquidity.” 

That liquidity injection into the economy amounting to trillions of dollars also explains why bankruptcy filings are lower than many expected. BPM’s Steiner anticipates more bankruptcies ahead by what he calls “zombie companies.” 

“They’re sort of in limbo,” Steiner said of these troubled companies. “This is where we thought we’d see a bank foreclose or a landlord evict, but we’re not seeing any of that. Everything is in a holding pattern. The banks and landlords don’t really want to deal with the level of pain this would cause.” 

Internal Affairs  

While some companies are walking zombies, others are clearly on a roll. In addition to DocuSign, San Francisco-based Slack Technologies also got a lift with more Americans working from home. A point not lost on Wall Street, where the company’s shares are up about 65% since mid-March. 

“Succeeding in this new, remote-first world requires much more than just replicating at home the same processes we once carried out in a physical office — it depends on a fundamental reimagining of work and the employee experience,” Robby Kwok, senior vice president of people at Slack, said of the opportunity he sees for the company. 

“It is not just about the tools and technology you work with. It’s really about the culture and norms your employees work within, and how you create that culture and propagate those new norms in a work-from-home environment.” 

Bay Area middle market companies are not only facilitating the digital transformation of other businesses, they’re quickly embracing digital in their own operations as Covid-19 forces change in how business is done.  

One trend with long-lasting impact is the reliance on communication channels that customers already use in their everyday lives, such as Facebook Messenger, Twitter direct messaging, WhatsApp and Apple Business Chat, among others. 

“There has been a drive to digital during the crisis, and we can expect when it’s over that customers will look to these channels more than ever for engagement as they provide easy and real-time solutions,” said Zendesk’s Berube. 

Invitae, which is focused on bringing genetic information into mainstream medicine, said it turned to telehealth to deliver more of its services in recent months, alongside an AI-based chatbot. 

The San Francisco-based company points to its creation of a chatbot for genetics, named Gia, that combined consumer-facing chatbot technology with a platform for health care providers, all in compliance with health care regulations. 

“There is one thing we know for sure: Now is the time to break free from outdated notions of how things should be done and to develop a new formula for success,” Kwok said.