March 07, 2021
Deals surge for small and middle-market companies
Aging baby boomers have helped fuel growth in the mergers and acquisition space — particularly for small-to-middle market companies — for a decade or more.
The lingering effects and realities brought about by the COVID-19 pandemic will likely add fuel to that trend, M&A advisers say. For that reason and more, 2021 appears likely to be among the busiest years in recent memory for M&A activity, according to a host of industry experts.
"It's unbelievable," Rajesh Kothari, managing director at Southfield-based investment banking firm Cascade Partners LLC, said of the current deal flow he's seeing. "We've never gone into a year with a stronger book of business as we've got right now."
That's due in part to aging business owners who have yet to make their exit now facing new realities, according to Jeff LaBine, principal and corporate partner in the Ann Arbor and New York City offices of Miller Canfield Paddock Stone PLC.
In the wake of the pandemic, businesses will be forced to upscale technology and a host of other processes to remain competitive, he said. Many aging owners will view the surging premiums that a financial or strategic buyer will pay as a preferred option to investing more money into operations.
"It's walk-away money," LaBine said of the premiums being paid for well-run small and middle-market businesses. "Or you can stay, take less cash flow, pump it back into the business and then you still don't know where your exit is. It starts influencing that decision. So I think it could accelerate those that are left."
Adding to that likely surge in dealmaking — which was already strong in 2020 despite a pause in the spring — is continued low interest rates and private equity funds having more than $1 trillion in capital, or dry powder, that needs to be put to use, according to Pitchbook, a financial data and software company.
'Holes in business model'
LaBine said much of the dealmaking he's seeing is being driven by companies "seeing holes in their business model" and that pandemic-induced lockdowns and halts to business operations "forced people to confront some things that maybe they wouldn't have had to confront," like ensuring that cash flow can remain steady and that services to customers can remain functional even if not done on-site.
As such, companies are on the hunt for tech functions that fill those gaps.
Indeed, one-quarter of companies surveyed for a February report by consulting firm Ernst & Young said that the acquisition of technology, talent, new production capabilities or innovative startups accounted for a main strategic driver of M&A activity.
"Businesses are looking to cross-sector targets to broaden their product and service offerings, a key differentiator in attracting and retaining customers in a fiercely competitive market," the Ernst & Young report says.
Such a notion fits with the strategy being employed by DaySmart Software Inc., an Ann Arbor-based scheduling software company that's been steadily growing organically and via acquisition, having completed two deals since December. The company now has more than 200 employees and over $40 million in revenue, according to CEO Patrick Shanahan.
As it continues to eye opportunities for growth via dealmaking, DaySmart is looking closely at
complementary companies to the markets it already serves, such as salons, spas and pet care service providers.
For example, in December it acquired AppointmentPlus based in Scottsdale, Ariz., in a deal that expands DaySmart into categories such as supply chain and logistics, health care, automotive and other segments.
"Not only those, but adjacent markets," Shanahan said. "And understanding what other markets do we want to go pursue and then making sure we find the right acquisition that allows us to have the right platform that's competitive and we can go take more share (of the) market in that vertical. We're always evaluating the platform. What do we think the growth opportunity is? The team that's coming with it."
For some who have recently completed deals, the pandemic has barely registered.
Samuel Spencer became president and CEO of Madison Heights-based vehicle telematics supplier Guidepoint Systems last month, following the close of a transition that lasted about four years and resulted in the retirement of the company's founder, Rand Mueller.
Despite uncertainty from the pandemic, the fundamentals of the deal more than withstood any
challenges, according to Spencer.
"This deal was four years in the making," Spencer said in an interview with Crain's.
"So the potential growth in the market share, the demand for Guidepoint's product and services, the ever increasing reliance and importance of mobility: that compelling investment thesis still prevailed," he said. "We're looking at a three-to-five-year horizon. Long-term investors are doing the same. That's why you still saw deals get done in the first half of last year ... and a surge in the second half."
Among those who recently completed a deal to sell their business was Dr. Scott Plaehn, who in January completed a sale of East Lansing-based health care practice Michigan Gastroenterology Institute to a Boston-based private equity group, HIG Growth Partners. MGI's affiliate, Capitol Colorectal Surgery Partners, was also sold in the deal.
Plaehn, MGI's president, told Crain's that the impetus for the sale, terms of which were not disclosed, was a desire to streamline the back-office business functions of the organization while allowing the practice to better identify future acquisition opportunities.
"We just felt like we had a lot of good ideas, but we could not really enact them and go to the next level and take the next steps," Plaehn said. "Obviously, we're clinicians and we were spending more and more of our time on nonclinical aspects of our practice to the point we were becoming concerned that we needed expertise."
Cascade Partners in Southfield served as the health care practice's financial adviser on the deal. Kothari noted that the current flurry of deals makes sense given that activity mostly halted early last spring due to the pandemic, but kicked back into high gear once businesses and advisers got acclimated to working remotely.
"Everything took longer," Kothari said. "You took the whole year and compressed it down to six months and now you're having things trickle over."
ESOPs as option
While traditional M&A deals continue at full blast, advisers in the space are also touting — in certain circumstances — an alternative option to provide liquidity for owners looking to make their exit: ESOPs.
Per data cited by the National Center for Employee Ownership, more than 6,400 companies in the United States have an Employee Stock Ownership Plan, where essentially the company's workers own the business.
Companies with an ESOP structure will typically still have a management team in place, but the business is employee-owned.
ESOPs tend to be a good option for business owners looking for an exit where, for a variety of reasons, traditional buyers may be reluctant to make the acquisition, according to Alex Conti, a managing director in the corporate finance practice of UHY LLP in Farmington Hills.
Companies with fairly low margins, smaller growth potential or those with more project-based books of business tend to stand out as good fits for ESOP candidates, he said.
"So there's challenging characteristics to a traditional M&A deal, and an ESOP is a great alternative for a business owner to actually get more in terms of value for the business," Conti said. "Albeit, some up front and the larger portion on the back end, or paid out over time. But it's just a great alternative to a traditional M&A deal for business owners."
Among those for whom an ESOP became a compelling proposition was Marty Easling, the founder and CEO of Easling Construction Co. in Leland, northwest of Traverse City.
Easling sold the close-knit company dating back nearly 50 years to his employees in a deal that closed at the end of 2019. In an interview, Easling told Crain's that other traditional dealmaking structures were explored, but the ESOP allowed for the best deal for all parties.
"This is the perfect solution for all the employees and for the company to keep going and take care of all our clients that we've developed over the years," he said. "It was just a perfect fit."