Last week the Wall Street Journal hosted the Middle Market Network to discuss issues relevant to middle market firms in the US. The good news is that middle market companies are getting healthier. With an increase in M&A activity and a boom in the construction industry, middle market businesses are growing and CEO confidence is high.

However, middle market companies still face challenges due to the global economic environment, disruption from technology, and industry and demographic shifts. Below are some of the issues that were discussed along with our commentary:

1. M&A

Middle market activity in 2016 was strong and we can expect robust activity to continue. Debt financing is still relatively inexpensive and the prospect of tax reform is also an incentive for deals. The demographic shift with baby boomers entering retirement and selling their firms also continues to drive activity.

2. Staffing

About half of middle market firms say a lack of talent at all levels impedes growth, according to Thomas Stewart of the National Center for the Middle Market.

Once recruited, middle market companies also struggle to keep employee engaged and satisfied on the job. Stewart suggests on the job training and collaboration with higher education so students learn the skills necessary for joining the workforce.

Another way middle market companies can fill this gap is by acquiring another company for key employees. Also known as an “acqui-hire,” this practice is commonly seen with technology startups, but can be applied to organizations of any size. In fact, identifying “star employees” is an essential part of due diligence.

3. Succession planning

Many middle market businesses have no plan for succession and those that do often fail to execute them.

Succession plans must be developed long before an owner exits in order to ensure the longevity of a company. It takes time to identify and cultivate individuals that can lead the company. Business owners should consider their goals and if anyone is capable and ready to take over. When no succession plan has been put in place, selling can also be option. For strategic acquirers, this is an opportunity to develop a persuasive offer for the company to sell to you. Determine what factors including, price and personal drivers would make selling to you more attractive how it will meet the owner’s goals.

4. Technology

Automation and technology are here to stay and middle market firms need to grasp this reality and act on it. Unlike large corporations who have the money to invest in the latest technology, many middle market companies have not embraced this change either due to lack of resources of fear from works that they will lose their jobs to robots. Marco Annunziata, GE’s Chief Economist, had a few interesting comments, noting “There will always be a human component” to technology. Whether or not this is true, technology has and will continue to dramatically change business.

Cybersecurity is another major concern and only 45% of middle market companies have an up-to-date defense plan. As the world becomes more digital, many companies find they are ill-equipped to deal with data breaches and the threat of hackers. Middle market companies may think cyberattacks only happen to large corporations like Target and Yahoo!, but the reality is no business is too small for hackers to target.

5. Healthcare

Changes in healthcare policy is a major concern for middle market businesses. 74% of firms attending said it would affect their business. With so much uncertainty, navigating the changes and planning for the future has become increasingly difficult.

 

Capstone Strategic’s survey of middle market executives shows most see the same (43%) or growing (31%) M&A activity in their industry. 47% are pursuing M&A in order to access new markets.

Capstone Strategic, the leading M&A advisory firm for the middle market, surveyed middle market executives from multiple industries on their growth and M&A experience in 2016 and their outlook for 2017. The survey was conducted in December 2016 and followed previous annual surveys of the middle market.

M&A activity across the board is mostly seen as the same (43%) or growing (31%).

Looking forward, our respondents are evenly split on whether or not they will pursue M&A in 2017. 35% are less than 50% likely to execute acquisitions and 35% are more than 50% likely. The top driver for pursuing M&A this year is access to new markets (47%).

As for obstacles to M&A, time and attention demanded by the process is the top barrier to pursuing acquisitions in 2017 (25%) while the most common reason for not considering M&A as a tool for growth is lack of appropriate target companies (28%).

The overall growth picture is improving. Those reporting modest growth rose from 58% in 2015 to 67% in 2016 and those reporting high growth grew from 11% in 2015 to 13% in 2016. Those reporting contraction shrunk from 9% in 2015 to 5% in 2016.

The business environment is seen by most in a positive light, with the majority reporting the same (50%) or an improved (35%) environment for growth. Compared to 2015, fewer executives saw a worsening environment for growth (8% compared to 13%).

Capstone’s CEO David Braun said: “The survey confirmed that 2016 remained an active year for middle market mergers and acquisitions and looking ahead, we believe we’ll see begin to see a renewed interest in M&A activity due to pent up demand and supply in the marketplace. 2017 presents a unique opportunity for companies that decide to execute strategic acquisitions.”

The full survey, State of Middle Market M&A 2017, can be viewed by clicking here.

 Feature Photo credit: dan Chmill via Flickr cc

Middle market companies have faced many challenges to growth, but the tide is now turning. Previously, we had observed the dumbbell effect, where at either end of the spectrum massive corporations and small businesses flourished while middle market companies were caught in between. Unlike large multinational corporations, many middle market companies cannot leverage the same economies of scale to deal with price cuts, consolidation, and regulatory challenges. On the other hand, middle market companies do not have the same flexibility as startups to move swiftly in the market.

The Dumbbell Effect

The Dumbbell Effect: Massive corporations and small businesses flourish at either end of the spectrum, while the middle market is squeezed in between.

 

Corporations Sell Non-core Businesses

While this environment was challenging, it also created a unique opportunity for those who could seize opportunity and fill the void. Now the market has shifted and instead of consolidating, many large corporations are shedding non-core businesses in order to focus on fast-growing, profitable business units. P&G is in the process of selling 105 brands to refocus on 10 fast-growing category-based business units. Recently P&G sold Duracell to Berkshire Hathaway, various hair care brands including Pert, Shamtu and Blendax to Germany’s Henkel, and its fragrance, color cosmetics and hair color business to Coty.

Growth Through Strategic Acquisitions

Divestments by large corporations can generate opportunities for middle market companies looking to grow rapidly through M&A. With acquisition, middle market companies have the opportunity to quickly execute their growth strategy, whether it’s by adding a new product or service, acquiring a competitor, or expanding into a new geographic or vertical market. Overall, middle market M&A has remained relatively stable when compared to global values, suggesting that although mega-deals may be slowing down, smaller, strategic acquisitions are still being executed. Now is the time to carefully consider your opportunities and execute your growth strategy.

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Middle market deal activity reached its lowest level since 2009, according to Mergers & Acquisitions. This may be a result of concerns about the upcoming U.S. presidential election and because banks are shying away from lending to private equity-backed deals.

While middle market M&A activity is down, when compared to 2015 levels, the middle market as a whole is actually leading the U.S. economy in revenue and job creation. According to the Middle Market Indicator, the middle market grew at a rate of 6.3% over the past twelve month while the S&P 500 growth rate was -3.4%. The projected twelve month growth rate is 4.6% for the middle market.

So how should an owner or executive see this paradox? In a word: opportunity. With continued strength in the middle market, but a decline in deals, you have the chance to move more freely than when M&A is hot.

If other companies are paralyzed by uncertainty, you should be emboldened. Seize the opening to pursue transactions while competition is reduced.

M&A can be the best way to own the future, by claiming new market share, adding new technologies, enriching your brand, or expanding your human resources.

But where to begin?

Your first step is to review your current market and identify predictors for future demand. What are your customers buying today? What will they need tomorrow? You probably have an approximate idea but now is the time to conduct thorough research, so you can spot the gaps that your company could fill.

The next step is to consider how strategic acquisition could position you to meet future needs faster than organic growth.

Especially if you have a strong balance sheet, right now is an exceptionally opportune time to accelerate your growth through mergers and acquisitions. So make a plan, and then act.

Capstone’s survey of middle market executives shows 53% likely to pursue mergers and acquisitions in 2016 compared to 41% when last surveyed.

Capstone surveyed middle market executives from multiple industries on their growth and M&A experience in 2015 and their outlook for 2016. The survey was conducted in December 2015, and followed a previous survey in 2014.

Respondents gave a mixed picture of growth for their industries in 2015. More respondents saw extremes in their industries. Those reporting high growth grew from 4% in 2014 to 11% in 2015, while those reporting contraction grew from 2% in 2014 to 9% in 2015. Between these two poles, most respondents were seeing modest growth in their industries during 2015 (58%).

How likely is it that your company will pursue some form of M&A or external growth in 2016?

How likely is it that your company will pursue some form of M&A or external growth in 2016?

The environment for growth in 2015 was seen by most in a positive light, with the majority reporting the same (46%) or an improved (36%) environment.
M&A activity across the board in 2015 was mostly seen as the same (36%) or growing (33%) when compared to 2014.

Looking forward to the coming year, companies showed a stronger inclination to engage in M&A, compared to predictions when we last asked this question in 2014 (53% certain or likely, compared to 41%).

When asked about their growth goals, respondents were evenly split between “selling current products in new markets” (40%), “creating and selling new products in current markets” (36%), and “increasing sale of current products in current markets” (38%). (Some respondents were pursuing more than one goal).

As for barriers to engaging in M&A, these were largely internal, with respondents citing “lack of resources” (33%) as a primary reason not to pursue transactions.

Capstone’s CEO David Braun said: “This survey confirms what we ourselves observed, that 2015 was an active year for middle market M&A and 2016 is likely to prove an even stronger year. We see a growing polarization between growth-focused companies and those that are sitting on the sidelines. While many companies are still holding cash, more players are emboldened to expand through external growth. This includes acquisitions but also minority ownership deals, joint ventures and strategic alliances. When growth stagnates, M&A can often provide the fastest path forward. When growth is high, companies should seize the opportunity to plan for further expansion.”

The full survey, State of Middle Market M&A, can be viewed by clicking here.

Instead of investing in growth, companies this year have been holding more than $1.4 trillion in cash – close to a record $1.65 trillion in 2014. Oracle’s $56 billion cash stockpile is 1.5 times its sales and Cisco’s $60 billion in cash is 1.2 times its sales. Eleven companies have cash reserves double their annual revenue.

And it’s not just Fortune 500 companies. According to the Middle Market Center, more middle market firms plan to hold onto cash in 2016. Fewer of them are willing to invest extra money or plan to expand in 2016.

Have U.S. Companies Stopped Investing In Growth?

Companies that stockpile cash don’t invest in stock buybacks and dividends, research and development, other organic growth initiatives or mergers and acquisitions.  A strong balance sheet is important, but the levels of cash held by nonfinancial S&P 500 companies is astounding!  They may be worried about the economy or the upcoming elections. But there’s another possibility: all that money on the sidelines portends robust M&A activity in 2016.

Tax Savings

Publicly traded companies also are stashing profits offshore to avoid paying taxes on them. The U.S. corporate tax rate is one of the highest in the world and tax inversions in particular are being driven by the pursuit of tax savings rather than for strategic reasons. .

The latest example is Pfizer and Allergan’s proposed merger which would relocate the company to Ireland and away from the U.S. corporate tax rate. Other companies that have done this include Chiquita, Perrigo, Medtronic, Endo, and Actavis despite calls for stronger restrictions on tax inversions by Congress and President Obama. Pfizer already has found ways to save on taxes even without the acquisition. The company has designated $74 billion as “indefinitely’ invested abroad.

Invest in Growth Now

As other companies hold onto cash, you have a unique opportunity now to invest in your future. Do this by developing a long-term strategic plan, investing in new products, services or equipment, or growing organically. Or pursue the faster, more powerful vehicle of strategic mergers and acquisitions. Middle market companies can seek privately held, not-for-sale deals that focus on long-term growth rather than on cost savings or short-term quarterly updates with shareholders. This increases the likelihood of a successful transaction and sustainable growth.

Middle market companies cannot afford to dwell on cost savings and sit idle. Make sure you are thinking about long-term growth and how your company will not only survive, but thrive.

Is your company hoarding too much cash? Or are you investing in future growth?

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The top five deals announced in Q1 2015 were all well above $10 billion. In comparison to last year, the number of mega deals announced, or acquisitions over $5 billion, doubled. Last year there were 14 mega deals in the first quarter and this year there were 28.

Despite the record-breaking activity of Q1 2015, global M&A in April 2015 slowed – both in terms of deal value and number of deals. Reports attribute that to the macro environment and instability in Europe and emerging markets. However, mega deals ─ many driven by consolidation ─ have still pushed up M&A value in multiple industries, including pharmaceutical and TMT.

What’s so important about these mega deals? Simply put, any large deal will certainly have an effect on the market. Significant transactions are like earthquakes. We’ll see aftershocks in the market in the form of divestitures and other acquisitions – both large and small – as businesses rush to stay relevant and adjust to industry changes.

Mega deals are also an indication of the trend I’ve previously talked about, the dumbbell effect; creating more very large and very small companies with fewer in between. The result is a void in the middle market and I anticipate a rush to fill that space.

Top five deals in North America for Q1 2015

Top 5 Industries NA Q1 2015

Capstone’s State of Midmarket M&A Q1-Q3 2014 Update indicates a steady growth in midmarket mergers and acquisitions.

We surveyed midmarket executives from multiple industries to learn how the first nine months of 2014 matched expectations from 2013, and to indicate any new trends in midmarket M&A. The survey was conducted in October 2014, and follows a similar survey conducted in December of 2013.

Midmarket M&A activity continued to increase despite economic uncertainty. More than half of the respondents (60%) engaged in M&A or external growth activities in 2014 and 44% are considering M&A in the last quarter of 2014.

Of the midmarket executives polled, 64% reported “modest growth” in their industries compared to 62% in 2013. “High growth” responses dropped by half from 8% to 4%. Perhaps most significantly, 24% of respondents reported stagnation in 2014, double the amount reported in the same period last year. This holding pattern may indicate continued anxiety about the economy, the political environment and government regulation.

David Braun, Capstone’s founder and CEO, noted, “As organic growth opportunities remain modest or stagnant, executives are continuously looking for new ways to grow, including mergers and acquisitions.”

While midmarket executives seem to be showing a renewed interest in M&A, they acknowledge there are hurdles to embracing external growth. Lack of time, people and money continues to be the greatest barrier to pursuing mergers and acquisitions with over half (52%) reporting insufficient resources as their biggest challenge. Insufficient resources also topped the 2013 chart (54%). 24% of those surveyed also said slow decision-making continues to be a hurdle.

In 2014, the same percentage of executives as in 2013 (28%) reported that they were concerned about the lack of suitable companies to purchase. About this Braun said, “It may be difficult to find suitable companies to acquire among those that are offered for sale. Restricting your search to for-sale opportunities is usually a mistake. At Capstone we encourage clients to expand their search and actively pursue not-for-sale acquisitions.”

Based on its survey and firsthand contacts with the market, Capstone predicts the economy will continue to recover, and as it does more midmarket companies will seize on the opportunities presented by external growth.

Braun said, “External growth embraces any strategy that leverages a relationship with another company, including strategic alliances, joint ventures, minority interest and acquisitions. When it comes to pursuing an acquisition, here’s one principle we’ve learned from years of experience: They are all for sale…for the right equation.”

The full survey, State of Midmarket M&A: Q1-Q3 2014 Update can be viewed at www.SuccessfulAcquisitions.net/report.

With a 70% failure rate for acquisitions, it seems like the odds are against you from the beginning. Before you get scared off, however, let’s take a closer look at what that 70% means.

The 70% failure rate is mainly based on large, publicly traded transactions because large transactions must be reported to the SEC, and information on public companies is generally available. In addition, these large transactions tend to make the news more often since people are fascinated by massive deals involving well-known brands.

Despite this focus on large acquisitions, there are hundreds of smaller, unreported transactions involving middle-market companies and privately held businesses.

We call these types of deals “taking small bites of the apple.” Instead of huge, transformative deals, which tend to be a bit difficult to swallow, smaller, strategic acquisitions achieve a higher rate of success.

Acquisitions are a powerful tool for sparking growth and may be the only way for you to reach your goals. Acquiring smaller companies does not completely eliminate your risk, but conducting multiple, smaller acquisitions, enables you to take manageable steps to executing your growth strategy.

As with any business initiative, you must take some risk to reap the rewards. Following a carefully planned strategy and a proven process will help minimize your risk and optimize the success of your acquisition.

Mergers have hit a seven year high.  While deal value is up 73 percent, the number of deals has decreased 0.4 percent, according to Reuters data. This confirms what we’ve been seeing since last year: larger, fewer transactions. With mega deals on the rise, we will likely see more activity in the middle market as confidence levels improve and executives become more likely to pursue acquisitions and execute deals.

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Midmarket deal flow expanded at the fastest rate in six months, according to a study conducted by Mergers & Acquisitions in April. The survey has positive implications for midmarket growth. As I’ve mentioned previously on my blog, midmarket companies have faced increased competition from larger players and small mom and pops.  Faced with this “squeeze,” it’s likely midmarket companies turned to M&A to spark growth.

A minority of investors have expressed concerns that midmarket activity may actually slow down in 2014, compared with 2013 activity levels.  Growth in the middle market may plateau for a few reasons all of which hinge on uncertainty in the economy including sequestration and the ongoing open-discussion over the U.S. debt ceiling. Health-care reform costs and talent gaps may also contribute to a slowdown in 2014.

According to a survey conducted in Q3 2013 by the National Centre for the Middle Market (NCMM), middle-market companies (generating between $10 million and $1 billion), in revenue can expect slower expansion over 2014 as revenue and employment growth are expected to slow over the next year.  This quarterly survey took responses from 1,000 C-level executives. The responses showed that on average revenue is expected to grow at a lowered rate of 4.4 % through the next year compared with the 5.1 % estimated from the previous quarter. Additionally, only 61 % of the middle-market executives surveyed said they would invest an extra dollar if presented with that opportunity as compared with 64 % last quarter.  Furthermore, the survey found that hiring among midmarket companies is expected to grow only 2.1 % over the next year, a drop from the 2.5 % predicted last quarter.

This post is part of a series addressing current and expected viewpoints on M&A from across a number of professionally relevant sources. 

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What will 2014 look like for mergers and acquisitions? While no one knows what the future holds, I see these three trends continuing:

1. Increased middle-market M&A

Middle-market companies are the primary driver of economic activity in the U.S.  With favorable market conditions, expect an uptick next year. A survey by Mergers & Acquisitions  showed a positive outlook for 2014; 71% of respondents expect a better year for mid-market M&A than 2013. They identified healthcare, technology, energy, and manufacturing as the top sectors for growth.

Increased M&A activity, especially in the middle-market, is an indicator of an improving economy. Executives are more likely to make deals when they are confident in the economy and the markets.

2. Healthcare consolidation

The Affordable Care Act has massive implications for the healthcare industry, but no one can say for certain what those implications are. Amidst all the uncertainty, the healthcare industry is seeing a significant amount of reshuffling, led by two big hospital consolidations this summer. We’ve also seen the rise of new products and services like private health exchanges. Look for this trend to continue in 2014 resulting from healthcare regulations.

3. “Acqui-hiring”

“Acqui-hiring” refers to recruiting a team of employees by buying a company. This is often the easiest way to attract top talent. For example, under CEO Marissa Mayer’s leadership, Yahoo! has acquired 30 companies for their technology as well as for their talented engineers. With their latest acquisition of PeerCDN, Yahoo brought on three new engineers. Other recent acquired companies like EvntLive and Ptch will be shut down, with the employees joining Yahoo’s team.

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Last week, Sysco announced it would buy rival US Foods for nearly $3.5 billion. Sysco is already a huge player in the food industry with customers ranging from the US military to schools to five-star restaurants. This deal brings together the two largest food distributors in the US, increasing Sysco’s share of the food distribution market from 18 percent to 25 percent. This acquisition is the latest in a trend of consolidation that we’re seeing in many industries. I call it the dumbbell theory.

What I see is that the number of middle market companies—I’m talking about companies roughly $100 million to $500 million—has been progressively shrinking while the number of large players and small mom and pops increases.  As the Sysco-US Foods deal proves, there’s no shortage of healthy and growing multinational monsters.

The dumbbell theory

The number of middle market companies shrinks while the number of large players and small mom and pops grows.

In the middle, we’re seeing a silent squeeze. For a multitude of reasons—to do with technology, globalization and the structure of the labor markets—it’s become more difficult to cruise along in that middle ground between “small but dynamic” and “huge but invincible.”

While the dumbbell theory may ring true, this doesn’t mean middle market players should hang back from M&A. Fortune favors the brave, and success in business tends to favor the contrarian. The very fact that so many companies are gun-shy about external growth creates an environment of opportunity.

What matters is your underlying strategy. So long as you have a single, clear purpose to guide your expansion, this could be the very best time to partner with another company. (And remember, acquisition is only one of many ways to do this.) Let others relive their nightmares of 2008 if that’s what they choose. In reality, we’re coming up to 2014—and the field is wide open for you to make it your best year ever.

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As you move from developing the strategic foundations for growth to implementing your growth plan, think about the different pathways to growth. Choosing the right pathway for growth is considered to be the heart of business. In the Association for Corporate Growth (ACG)  blog, I outline some of the strategic pathways you can take for growth, including acquisition.  I invite you to head on over to their blog to learn more about which pathway may be right for you.

 

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