This article first appeared in Hub Lite.
Mid-sized businesses (MSBs) are increasingly finding themselves sandwiched between global giants and a new wave of micro to fast growing disruptors, reported Praxity in April 2018. The article – The Challenges of Being Mid-Market – described that in today’s competitive, regulated and technology-focused world – MSBs are often regarded as the ‘forgotten army’.
Yet, being overlooked doesn’t appear to be deterring global entrepreneurial activities. Quite the opposite. Small to medium sized enterprises (SMEs) are the most common businesses found across most of the world’s economies. There are now between 365-445 million micro, small and medium-sized enterprises in emerging markets. The World Bank estimates, 25-30 million are formal SMEs; 55-70 million are formal micro enterprises; and 285-345 million are informal enterprises.
Often regarded as the economic engine room of countries such as Germany – where they form the “Mittelstand” group of highly innovative, export focused small to mid-sized companies – access to finance has, until now, remained a key constraint to growth. Without this access to capital, many SMEs languish and stagnate.
“The risk in remaining a very small business is you cannot achieve the scale needed to survive and thrive in an increasingly competitive national and global market,” comments William Buck Adelaide’s Managing Director Jamie McKeough.
Now, however, squeezed mid-sized firms are commanding the attention of investors, who seem to favour SME acquisition deals over mega mergers. Part of the rationale has been attributed to higher value creation, with a Harvard Business Review report last year evidencing ‘infrequent large deals do tend to hurt value creation. Instead, it is a steady stream of transactions – known as programmatic M&A – that delivers the real wins. But these transactions need to reach particular thresholds of frequency and cumulative value to make a real impact’, said the report.
Start small … think big … scale fast
Speaking recently about what it will take to push the South Australian economy to the next level, Jamie said more small enterprises would need to merge together to become ‘’M’s’.
“We are all in business to grow. It’s in this expansion phase where the larger share of future jobs will be created. Many of the world’s most successful companies began small but got where they are today by thinking big.”
“Greater consolidation among micro and small-sized local businesses should be encouraged in the coming years for the benefit of the entire state. This would help local businesses reach the critical mass to survive in an increasingly competitive environment. It will also allow them to pitch for more work and in doing so, protect and create more jobs,” claims Jamie. “As well as unlocking greater efficiencies of scale, it would also help to attract more in-bound investment.”
His comments come as a recent Business SA – William Buck survey found that 57% of businesses are targeting growth in 2019, either by organic means or through merger and acquisition.
However, the opportunities to grow by M&A can be difficult to unearth. Only 19% of businesses surveyed by William Buck and implementing their succession plan, indicated that they want to sell to an external party as opposed to intergenerational transfer or management buyouts.
“This is creating a worrying market disconnect for operators seeking to grow by M&A,” Jamie says.
“Faced with this limited opportunity on the open market, we need growth-hungry businesses to be more pro-active and adventurous to bridge the gap.”
Dealing with the urge to merge
An acquisition isn’t for everyone. Understandably, micro and small business operators who haven’t done this before are often unsure how to initiate M&A discussions with potential parties. For businesses of all sizes the prospect can be daunting.
“Finding the right strategic business partner or target and executing the deal can be easier said than done,” says Jamie. “An M&A transaction doesn’t happen overnight but instead requires a large amount of planning, due diligence and many conversations over coffee.”
The first step is to draw up a list of potential suitors if you’re a seller, or acquisition targets if you’re a buyer. From the outset it’s important to engage with a trusted advisor who can assist by streamlining the process and identifying the best possible options for your business.
Last year, nearly two thirds of Institute of Director (IoD) members (64.3%) said that they would consider an acquisition as a conduit to growth. This appetite for M&A mirrors wider market trends, with the Institute for Mergers, Acquisitions and Alliances (IMAA) recording a 7.3% increase in UK deals in 2017 compared to a 2.9% rise globally.
UK Corporate Finance specialist, Leighton Bower from Rouse Partners comments: “The UK M&A market has remained buoyant in recent years and is still a viable route to growth for domestic and international firms. We are currently seeing investors become more cautious as economic and political uncertainty intensifies. However, I expect this ‘wait and see’ approach to subside as the UK’s position becomes clearer.
Additionally, the fall in value of the pound is driving international interest in the UK. Leighton adds: “For those looking to embark on cross-border M&A it is vitally important to have ‘feet on the ground’ to review and provide due diligence. This will give you confidence in who you are dealing with and a better understanding of your target and their strategic fit. This is where Praxity and its collective of member firms around the globe can provide a joined-up service and offer added assurance at a local level. There are a lot of considerations when assessing potential targets and I would always recommend having your team of advisors lined up as early as possible in the M&A process to help with this.”
Mittelstand M&A fever
The trend towards smaller deals is equally prevalent in western Europe, particularly Germany where SMEs make up 99% of all enterprises. But, with a whole generation of post-war entrepreneurs queuing up to retire, by 2022 one in five German SMEs could face a change in ownership or closure said a recent report by KfW Banking Group.
Chief economist for the German lender Jörg Zeuner cautioned: “The Mittelstand is going to be hit by a wave of succession that will change its face.”
Sentiment however often dissuades German SMEs from selling to private equity investors. “These companies are founded on family principles and have been built from the ground up,” comments Steffen Ahrens. “As well as feeling a strong loyalty to staff, they want their legacy to live on.”
For 54 per cent of all German entrepreneurs seeking retirement in the coming years, keeping the company in family hands is the preferred option said the KfW report. Only 42 per cent would consider an external sale.
Yet, with data from the report revealing that 100,000 entrepreneurs who want to retire over the coming two years have not yet found a successor, there could a merger bottleneck. It’s leading to heightened interest from foreign investors, which Germany and other EU states are taking steps to control.
In a move to fend off unwanted takeovers in strategic business areas by non-Europeans – particularly Chinese investors – Germany recently tightened their foreign investment rules. “This was done in an effort to lower the threshold for screening and even block the purchase of shares in German firms by non-Europeans,” explains Steffen. EU states have also agreed a wider-reaching system to scrutinise foreign investments in a more coordinated manner.
Given the complexity and politics involved in helping SMEs plan for the future, Praxity recently conducted a survey among member firms to gauge the appetite of introducing a facility where firms can share potential M&A opportunities. Several firms at the Praxity 2018 Global Conference in Sydney initially mooted the idea, which has now been taken to the next phase.
Championed by Andy Ryder, Corporate Finance Partner at Praxity’s newest member firm, Shorts, with the backing of Falk, William Buck and Shinewing, the idea would be open up potential suitors to investors and visa versa. As well as forming an official Working Group, they hope to launch an online M&A sharing board.
The survey data is currently being analysed. Results will be communicated in a future edition of HUB Lite. But with more the 50 responses, there is clearly strong demand for a forum to advertise clients’ M&A opportunities to the international market.
Andy explains: “What this global interest in SMEs illustrates is there is a growing appetite for SMEs to scale up or extract value from their business. This is leading to M&A for all sizes of businesses becoming increasingly international in nature. I am a firm believer that the scale and expertise within the Praxity Alliance can therefore be a powerful tool in helping our clients successfully execute M&A.”
He adds: “SMEs who haven’t done this before tend to need a lot of hand holding. For example, it’s a big deal to formulate an exit strategy when you have dedicated years to building up a business. The clients we serve really benefit from our ability through Praxity to ‘match make’ buyers and sellers across the globe. They also appreciate the fact that, through Praxity, there are firms and organisations on the ground in other parts of the world that can help clarify the corporate finance, tax, funding and the legal implications and demystify the process.”
Watch this space for the results of the Praxity M&A survey. Meantime, if you have a M&A opportunity that you wish to pitch out to the Praxity audience, their upcoming conferences provide an excellent opportunity to run ideas past likeminded corporate finance specialists. You can also find a global expert filtering by location and specialisms using the Praxity Our Firms directory.
To find out more about your gateway to global opportunities, read more about our William Buck and Praxity alliance.