by Scott Bushkie. CBI, M&AMI

Here at Cornerstone, we were analyzing our buyers for 2013. What we found is that existing companies (aka strategic buyers) were the most active. These strategic buyers are acquiring companies significantly more than individuals and private equity firms.

The trend is surprising because a recession usually produces a lot of new entrepreneurs.  Many talented people either get forced out during downsizing or leave voluntarily in order to take control of their own professional futures. So we should expect to see a lot of individual buyers right now.

We would also expect to see more private equity (PE) activity.  PE firms had their best fundraising years in 2006 and 2007 and, due to the Great Recession, are running out of time to put that money to work.

But while our experiences run against expectations, other M&A advisors across the country are seeing the same thing. According to the Q2 2013 Market Pulse Survey (conducted by the IBBA, M&A Source and Pepperdine University), existing businesses are the number one buyer for most of Main Street and the lower middle market right now.

Of note, individual buyers were still tops in the $500K and under sector.  Private equity didn’t really get in the game in any significant way until deals topped $5MM in value.

Growth Mandates.  I should point out that some of this reporting may be flawed.  We can’t tell from the research whether any of the strategic buyers were operating solely on their own initiative or whether these were firms already backed by a private equity group.

Either way, the trend still shows that companies are very aggressive right now in purchasing and growing through acquisition.  The market traditionally ebbs and flows with the number of companies attempting to grow through “buy versus build” strategies.

But the economy is still growing at a fairly slow pace and companies have record amounts of cash sitting on their corporate balance sheets.  Organizations have the incentive and the wherewithal to grow through acquisition, and they’re doing it very successfully.

I’m also guessing many companies might be doing their first acquisitions and are looking for lower-risk “starter” deals.  With available cash on the balance sheet, companies can take a calculated risk by acquiring a smaller operation.   If you’re a $20MM company buying a $2MM business to gain a little market share, you know that even if the acquisition is a bust, it won’t be fatal to your organization.

It’s also worth pointing out that existing companies usually aren’t the most common buyer group for deals under $2 million, but this quarter they were.  My guess is that private equity firms are focusing on larger transactions as a way of playing catch-up after the recession.  That’s pushing strategic buyers downstream to smaller companies where the competition isn’t as great.

And competition is an issue right now.  According to the Market Pulse Survey, 76% of advisors agree the M&A market doesn’t have enough quality businesses for sale versus the number of potential acquirers, especially in the lower middle market, defined as $2-$50 million in business value.

Strategic Advantages.  I do want to be clear that when we talk about strategic buyers, we usually aren’t talking about your competitor down the street.  Attempting a sale to a competitor can be a very dangerous proposition that rarely results in a top dollar deal.

There are any number of synergistic reasons another company could look to purchase yours.  These companies could be looking for a new markets, new products, new customers, or any combination thereof.  Many of our sellers are surprised at how expansive the synergistic buyer pool really is – usually three to five times larger than they could brainstorm on their own.

Looking specifically at Cornerstone’s numbers, both for closed deals and those in the Letter of Intent stage, we are trending at 75 percent strategic buyers, compared to 20 percent PE firms, and 5 percent individual buyers for the year.

One of the reasons strategic buyers have been so successful is that they typically have an advantage over financial buyers (individuals or a private equity firm platform) who look at acquisitions solely from a cash flow standpoint.  An existing company can look at additional growth opportunities, cutting out redundant costs, combined distribution channels and a whole host of other tactics that allow them to pay more and still get a great deal.

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A thought-leader in the industry, Scott developed the Cornerstone Process to offer investment banking M&A-level services to the lower middle market. The result is a closing ratio that’s more than double the national average.