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Four Trends Impacting Lower Middle Market M&A Activity

The Deal.com did a very helpful analysis of the 2007 U.S. Economic Census. According to U.S. Census data, 369,122 companies constituted America’s middle market in 2007, double the number registered in 1992. Further analysis of the data finds that 174,000 of these companies, or about 50%, have reported revenues between $5 and $10 million, and 177,000 have reported revenue between $10 million and $100 million.

While traditionally the middle market is defined as companies with revenue between $5 million and $1 billion, US Census data suggests that 95% of the middle market is made up of lower middle market companies.

A confluence of factors is starting to point towards a more active capital raising and M&A market in the coming two years that will send overall deal flow activity higher. As a result, we’ve identified four trends that will impact the middle market:

  1. Inventory – In a recent Axial survey, 48% of sellers indicate that retirement is the number one reason for selling their company. The first of the baby boomers are turning 65 this year and others are approaching retirement imminently. While the golden era of 2005-2007 valuations may never return, sellers owning high quality companies have been waiting patiently on the sidelines for better economic conditions to bring their companies to market, and are likely to consider the current conditions as “good enough” to pursue their exit strategy.  Additionally, private equity firms waiting to maximize their return have also been waiting out the recession with over $477 billion in committed but undeployed capital [PDF] and have been holding on to companies longer than intended. As the pressure to “show some exits” increases, Private Equity Groups are taking advantage of favorable market conditions [PDF].
  2. Quality – According to a World Economic Forum report, companies backed by private equity are “on average the best-managed ownership group.” Management practices were categorized as operations management, monitoring, targets, and incentives. With the impetus for private equity firms to exit their portfolio during the improved market conditions and as a core requirement before being able to raise their next fund, more portfolio companies backed by private equity groups will drive higher quality lower middle market deal flow. In addition, the recession has forced companies to operate leaner and more efficiently to cope with flat sales and cautious customers. As the economy improves, companies can begin to expand while operating from a leaner base.
  3. Credit Markets – In GF Data Resource’s first quarter 2011 report, B. Graeme Frazier, IV, Principal and Co-Founder of GF Data, indicated that credit markets are beginning to loosen up. “What’s really important to note in this quarter’s data is that total and senior debt multiples held steady from the previous two quarters. In terms of multiples of adjusted EBITDA, total debt remained in the low three’s and senior debt in the low two’s, confirming that debt continues to be available in the middle market, which is a welcome improvement from where we were a just a year ago.”
  4. Use of Technology in M&A – As more and more M&A Advisors and business owners begin adopting and using technology to better market opportunities and more efficiently identify qualified buyers, the ability for companies and private equity firms to build a pipeline of acquisition candidates is becoming more and more systematic. Considering how large the middle market has become, it has a staggering impact on how M&A Professionals market themselves and shape their deal origination and client acquisition strategies, making it nearly impossible to maintain a consistent and meaningful presence in the marketplace. We’re seeing more and more tools available to M&A professionals to perform research, market themselves, and communicate. These tools range from deal management, deal sourcing tools, and seller relationship management tools like Axial, cloud based document management solutions, and email solutions.

With such an expansive middle market and improving economic conditions, we’ll continue to see an evolution within M&A. Let us know below if you’ve seen any of these trends or been impacted by them in any way.

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