Parts I and II of our conversation focused on the evolution and risk management issues inherent in M&A activity and the middle market. Part III concludes with a discussion of risk management issues that may affect middle market companies in the future.
Russ Warren, national expert on the evolution of the M&A market and middle market businesses. How do you define the middle market sector as compared to larger organizations?
In cultural terms, it is Main Street compared to Wall Street. In size, it is often agreed to be revenues of about $10 million to $500 million, except in New York where its deemed anything under $1 billion. When you see M&A statistics, remember: the number of transactions reflects activity level in the middle market and the value of transactions reflects activity level in large public combinations. (Two or three multi-billion dollar deals will bump the value, but not the number of transactions.)
How have megatrends like consolidation, technological change, and globalization affected middle market companies?
During the 1990s, owners of smaller U. S. companies in many sectors began to feel increasing pressure (beyond the tendency of mature industries to consolidate) on profits and their very existence. Large customers winnowed suppliers to those with critical mass and scope. The rising cost and pace of technical change required major capital investments more frequently. And, globalization increasingly impacted middle-market businesses.
The term “Critical Mass” took on new importance. Owners were told, “Get bigger or get out.” To remain globally competitive, major multinational corporations formed close working relationships with fewer suppliers because it was just too expensive to buy a few items from a lot of suppliers.
Product life cycles and product-to-market cycles became shorter. Each new technological development tended to require a larger investment, and required such investment more frequently, just to keep up. Small companies needed a financial partner.
Globalization came to the middle market. In 1994, America entered the age of NAFTA, and freer trade globally. Less restrictive trade barriers presented both challenges and growth opportunities, but required more resources from participating companies.
Also in the 1990s, buyers’ strategic “add-on” acquisition initiatives sought more than mere financial return. This meant operational due diligence was more thorough and took longer, but risks to the careful buyer were lower and value-creating opportunities greater.
In your view, what are traits of successful business leaders in the middle market space?
The ability to ‘look around corners’ (anticipate what’s coming) and adapt to changing conditions. For example, a company that has grown from $10 million to $30 million requires different skills in the management team and greater financial resources.
The ability to delegate routine, less important matters in order to spend quality time planning and dealing with important developments. One CEO asks her sales and operations teams, ‘what has changed since we met last month?’
Monitoring available information about direct and tangential competitors and market conditions, and acting when opportunities and threats appear; keeping abreast of technological developments that could have a positive or negative impact.
What do you think are the major risks that will confront middle market companies over the next 10 to 20 years?
Wow! You saved the toughest questions for last. My crystal ball is cloudy after a few months.
I’m confident that ‘change’ will be ever-present, probably accelerating over that time. The trick to manage risk is to recognize what changes are meaningful and create a plan to deal with them as early as possible.
When an owner is trying to decide whether to sell or when, I like to ask, “Is time your friend?” and “Can you acquire the needed resources or pick your time to transition the business on your terms?” The answer to those questions help determine the course of action.
Does your answer to the preceding question change if we focus on “major opportunities” instead of major risks?
Opportunity is the other side of Risk, as the successful middle market business leader knows.
In cultural terms, it is Main Street compared to Wall Street. In size, it is often agreed to be revenues of about $10 million to $500 million, except in New York where its deemed anything under $1 billion. When you see M&A statistics, remember: the number of transactions reflects activity level in the middle market and the value of transactions reflects activity level in large public combinations. (Two or three multi-billion dollar deals will bump the value, but not the number of transactions.)
How have megatrends like consolidation, technological change, and globalization affected middle market companies?
During the 1990s, owners of smaller U. S. companies in many sectors began to feel increasing pressure (beyond the tendency of mature industries to consolidate) on profits and their very existence. Large customers winnowed suppliers to those with critical mass and scope. The rising cost and pace of technical change required major capital investments more frequently. And, globalization increasingly impacted middle-market businesses.
The term “Critical Mass” took on new importance. Owners were told, “Get bigger or get out.” To remain globally competitive, major multinational corporations formed close working relationships with fewer suppliers because it was just too expensive to buy a few items from a lot of suppliers.
Product life cycles and product-to-market cycles became shorter. Each new technological development tended to require a larger investment, and required such investment more frequently, just to keep up. Small companies needed a financial partner.
Globalization came to the middle market. In 1994, America entered the age of NAFTA, and freer trade globally. Less restrictive trade barriers presented both challenges and growth opportunities, but required more resources from participating companies.
Also in the 1990s, buyers’ strategic “add-on” acquisition initiatives sought more than mere financial return. This meant operational due diligence was more thorough and took longer, but risks to the careful buyer were lower and value-creating opportunities greater.
In your view, what are traits of successful business leaders in the middle market space?
The ability to ‘look around corners’ (anticipate what’s coming) and adapt to changing conditions. For example, a company that has grown from $10 million to $30 million requires different skills in the management team and greater financial resources.
The ability to delegate routine, less important matters in order to spend quality time planning and dealing with important developments. One CEO asks her sales and operations teams, ‘what has changed since we met last month?’
Monitoring available information about direct and tangential competitors and market conditions, and acting when opportunities and threats appear; keeping abreast of technological developments that could have a positive or negative impact.
What do you think are the major risks that will confront middle market companies over the next 10 to 20 years?
Wow! You saved the toughest questions for last. My crystal ball is cloudy after a few months.
I’m confident that ‘change’ will be ever-present, probably accelerating over that time. The trick to manage risk is to recognize what changes are meaningful and create a plan to deal with them as early as possible.
When an owner is trying to decide whether to sell or when, I like to ask, “Is time your friend?” and “Can you acquire the needed resources or pick your time to transition the business on your terms?” The answer to those questions help determine the course of action.
Does your answer to the preceding question change if we focus on “major opportunities” instead of major risks?
Opportunity is the other side of Risk, as the successful middle market business leader knows.
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