Private equity firms have $1 billion they’ve been sitting on for the last three years and are now looking for middle market investments that would pump up their bottom line. And corporate America, which had done its best to downsize in every way since 2008 including in research and development, is now looking to snatch up the middle market businesses’ cool new inventions.
Winning at this game will require the middle market businesses to know who is buying and what they value. And, the middle market firms headed for big paydays will be the ones who thought about how the game would end when they were just beginning.
It’s that kind of end game strategic thinking that separates the middle market businesses from the small lifestyle businesses, whose end goal might be to hand off their business to the next generation.
“Middle market companies sell more strategically,” said Chris Blees, president and CEO of BiggsKofford Capital Investment Bank. “It’s more about identifying the value proposition and then going and finding the right buyer as opposed to throwing it up against the wall in hopes that some buyer comes along.”
It takes careful thought and planning and some market intel on what companies find valuable including profitability, sales force, customers and research and development.
One middle market firm Blees worked with spent a few years doubling his company’s size thinking big contracts would be attractive to buyers. It turned out the buyers in his sector wanted profitability over volume. He had to start over with his exit plan, Blees said.
“I would say, ‘Are you building a valuable company?’ And, people say ‘yes’ and I say, ‘valuable to whom?’ “ Blees said.
Once a middle market firm knows what is hot from the buyer’s perspective, they had better start changing their game plan, Blees said.
“Every company eventually exits,” Blees said. “Either horizontally or vertically, you will exit your business.”
In January, Tony Colon sold his Colorado Springs-based Combat Training Solutions to Cyalume Technologies Holdings, Inc. for more than $5 million. It was something he planned since the day he started his company in 2005.
Colon, an aeronautical engineer, started Combat Training Solutions to build exploding devices that look, smell and perform like the IEDs soldiers encounter in Iraq and Afghanistan. He landed large government contracts in the U.S. and then took business overseas to grow revenue past $7 million.
His exit plan was part of his business plan, he said. He knew which companies were out there and which ones would be interested in his products.
“When you start, you should have the (exit) plan,” Colon said. “I estimated when I wanted to sell — that estimate was based on dollars and time.”
Middle market, big player
Most people forget about the middle market, Blees said.
“The politicians, the media and everyone else talks about Wall Street and Main Street as if that’s all there is,” Blees said. “They forget there is middle market which is just as big as the large businesses.”
Middle market businesses are typically defined as those with more than $5 million in revenue. Across the country there are between 200,000 and 300,000 middle market businesses compared to 5 million small businesses.
But middle market businesses are responsible for about 40 percent of the GDP — the same percentage as large businesses, which are typically defined as those with more than $200 million in revenue.
“The middle market is probably the healthiest segment of the local economy,” said Trevor Dierdorff, chairman of the Middle Market Entrepreneurs and president and CEO of Amnet, a Colorado-Springs based IT support company.
Middle market businesses are mature in business structure but nimble in responding to the market. That makes them attractive to buyers, he said.
With only a handful of companies going public each year, the rest of the middle market businesses will be bought by companies looking to expand their reach or companies interested in increasing their bottom line. More middle markets companies are being sold now as a percentage than small businesses, Blees said.
It just happens that two types of distinct buyers are circling the middle market, Blees said. The strategic buyer is looking for intellectual property and the financial buyer has money to spend because it had nothing to buy in recent years when smaller companies were taken down by the economy.
“Now it’s the perfect storm for the middle market company,” Blees said.
When the economy hit the skids, corporate American cut expenses, including its research and development, in favor if keeping profits up.
“For three years now there has been no R&D, no new product, no new market, no new geography, no new expansion,” Blees said.
It was the middle market businesses that kept innovating. That makes them attractive now to the bigger businesses that want their designs.
“Now, share holders want to see more than profit,” Blees said. “Now, they want growth. So, where do they go to get growth — they buy it.”
But, most middle market businesses have not planned their exit strategy, Blees said. They build their business based on what is valuable to them and not what is valuable to their future buyers.
“They say, ‘I love this so much someone else will come along and love it as much as me,” he said.
Exit, stage left
It could be that some middle market businesses are reluctant to think about the exit plan or make a five year plan, Colon said, because they are in love with their idea.
“One of the greatest fears of the prospective owner that prevents the business plan is the fear of recognizing that the plan won’t work, that it won’t be as profitable as they thought it would be,” he said.
But, a middle market business will not sell on a good idea alone, said Chris Younger, managing director CapitalValue Advisors, Investment Banking. Business owners have a strong intuition about risk but they have not thought about it systematically in order to make the changes to be ready to go to market.
“We are seeing buyers are much more discerning, more risk adverse,” Younger said. “As a result, deals are going to take longer. Companies that want to go to market should spend some time and make sure they have addressed the critical risk areas.”
Middle market companies in the same sector will have different strengths and weaknesses, Blees said. And that will attract different types of buyers. But, the companies that get paid the most are the ones that thought about how the game would end.
“If you want to sell five years from now, you have to prepare your company now,” Blees said. “That is the magic.”