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Little Big Deals: The State of the M&A Market for Smaller Transactions

A full audience was on hand at the Marriott Marquis in Midtown Manhattan as Eric D. Reuther (Stout Risius Ross Advisors, LLC), Daniela Bendor (Axiom Capital Management), and Steven D. Higgins (Baker Tilly) offered insight about the state of the market and the distinct opportunities and challenges that exist for investors. Stephen A. Reinstadler (SR Capital Advisors) moderated the discussion.

First things first — what’s happening in the market?

The first priority was to interpret the general state of the market. Overall, the panel concluded that 2015 was a very busy year for M&A activity across all segments but we may be reaching a plateau for favorable dynamics.

While we may be headed toward a soft landing, the panel expects certain sectors to remain very active — industrials are likely to benefit from low oil prices, and strong demand is still evident across technology, medical, food and beverage, and health and wellness, to name a few.

With excess capital available, how can private equity investors differentiate?

Capital providers are increasingly realizing that attractive investment opportunities can be found in companies of all sizes, including the lower middle market. Specific to smaller deals, investors wanted to know how to distinguish themselves during the bidding process.

The panel agreed that relevant industry specialization can be enough to “get you on the list.” Beyond that, investment bankers also consider past behavior if they’ve engaged with you before. That behavior may include whether the investor’s team has put the work in to review the materials, demonstrates purpose, seriousness, and intent to engage, and conveys a knowledge of the industry. In other words, don’t be surprised by factors that are specific to the industry. Bankers and business owners are also looking for consistency in participation from the investor team throughout the process.

It can be a long process, and advisors are looking for buyers who can add value. The key takeaway for investors looking at smaller deals is that it’s critical to earn the trust of the business owner.

Are there bargains to be had?

The panel generally concluded that if an opportunity is priced at less than market value, it could be a sign that there’s work to be done. This should prompt investors to look closely at the company’s people, systems, and customer acquisition strategy to gain more insight — and, accordingly, be ready to roll up their sleeves as needed to address any uncovered weakness or help “professionalize” the company.

Customer concentration is another topic that received attention from the panel and audience. Some wondered whether this is a consistent theme among middle-market companies, and one investor inquired whether a customer call is an appropriate tactic used to gauge customer loyalty. The panel agreed that customer calls are typically held as a last resort, but not ruled out as an approach to help investors get comfortable.

A crowded buyer landscape

While due diligence is a critical part of the process for prudent investors, the panel also described an investor landscape that has changed significantly over the past decade. Investor interest is now coming from many directions — from industry, strategics, PE firms, and even family offices emerging more frequently and positioning themselves as an attractive alternative. “It’s getting crowded — buyer lists are exploding, there’s a lot of competition, and the marketplace is more efficient. This makes it harder for investors to find that elusive, exclusive deal,” said Mr. Reuther. It was also noted that some investors deploy a search fund model — people who are essentially buying themselves a job. Members of the panel remarked that they unanimously make it a priority to look for investors who are high quality and have deep expertise to offer in a particular industry.

In conclusion

M&A activity is likely to remain strong during 2016, and the lower end of the market might just be the most vibrant. Interest from investors is on the rise, and the buyer landscape is only getting more crowded. Due diligence is critical in order to understand the unique dynamics of smaller deals, but that doesn’t diminish the appeal or potential for return on investment. The investors who have the greatest chance of success are those who can demonstrate relevant industry expertise, are willing to put the effort into reviewing materials, and will participate in the proceedings with purpose and intent.