Trends in Middle Market M&A and Capital Availability

Robust capital sought landing places and boosted mergers and acquisitions activity in 2021.

ACG’s February breakfast spotlighted trends in middle market M&A, how long they’ll last, how deals are getting done in the highly valued marketplace, and how these market dynamics can benefit various industries.

Bill Conway, managing director of CC Capital Advisors, moderated the discussion with panelists Jared Poland, partner with CPC LLC; Stephanie Schneider, partner with Five Elms Capital; and Tim Lewis, partner with Southfield Capital.

Conway sought each executive’s perspective on M&A and how they and their firms are using that capital.

“If you’re following along with me — I was doing the math — we have north of a billion dollars represented up here on stage,” Conway said. “So, money’s not a problem.”

Employing strong people with efficient processes and a strong management strategy are crucial for success, Poland said. Five Elms sees bigger private equity firms probably seeking businesses it has grown in its portfolio that then make more sense for bigger private equity companies to do business with, Schneider said. The bigger firms are coming down-market, growing more competitive and trying to invest earlier because of market tension.

“I think what we’ve certainly seen … is just this flight to quality, especially given all the pricing pressure in the market with folks having a lot of capital that they’re wanting to put to work … and also strong, quality management teams,” she said.

People have money to deploy and an impetus to deploy it, Lewis said. They’re willing to pay more, “but it better be a high quality asset” that’s “pretty tightly run.” Expectations have risen with valuations.

Conway asked panelists how inflation’s 40-year high and the problematic labor market affect their buying decisions and how they’re evaluating businesses for potential acquisition. Poland said it prompts a deeper test of a business’ adaptability and a good understanding of their customer base to meet the challenges.

Southfield focuses on business services and therefore more on people, Lewis said. The company hasn’t changed its investment strategy because of capital and other costs, but “what’s changed for us and me personally … is I’m thinking about human capital in a way I’ve never thought about it before. … You have to be thinking about human capital at the same time you’re thinking about your growth strategy (and) how you’re going to capitalize the business.”

Five Elms invests in software businesses, and, historically, the highest cost is for people, especially software developers, Schneider said. These companies recruit engineers “left, right and center,” especially on the coasts. But with decentralization and more remote working, many of its portfolio companies see that salespeople are becoming much more expensive.

Five Elms therefore must help its businesses decide whether to pay more for the next salesperson because another competitive software business will pay more, she said. If they do pay more, they must factor that into their sales efficiency to expand while limiting costs. And culture is key.

“We’ve found in all of our businesses that those that are most successful are those with the strongest cultures,” Schneider said, “because it permeates all the way through to their end customer. One wrong hire can really set a business back.”

Having a human capital executive on board who helps manage people is a best practice, Lewis said. Schneider said committing to hiring such an executive is among the first changes its portfolio companies are making, “so that they’re the ones waking up at 3 in the morning wondering how they’re going to get that next, best executive for their business.”

When evaluating a business, Poland looks for a niche the company excels in and can expand, and its brand value. Sound financials, high growth and high net dollar retention are keys, Schneider said. Lewis looks at how a company deploys capital and what its track record of successful M&A is.

Schneider stressed the importance post-COVID of returning to in- person meetings to establish partnerships. Lewis said COVID accelerated the trend of people thinking they don’t need to be in bigger cities “to be heavy hitters” because “we all functioned for two years on Zoom. It changes the notion of place and adds flexibility.”

Lewis thinks about what the constraints are.

“It’s not capital,” he said. “It’s good businesses and people. So, if that’s the strength and if you’re smart, that’s where you focus your time and energy. You still need to do all that other diligence.”

He asked: Will the business provide a place “where every day is a slog, or is this a business where it so works?” 

“It’s not effortless, but the business despite itself is successful,” Lewis said. “You always want those kinds of businesses. Beyond that, it’s the executive team and the culture. One person can be the difference maker.”