The volume of high priced Tech M&A deals, including megadeals of $1 billion or more, has declined recently as worries about the economy, war in Ukraine, and regulatory controls have made buyers wary of high-end purchases. According to its Tech M&A Report for Q2 2023, Market Intelligence provider CB Insights reported that the number of M&A deals of $100 million or more dropped in the first half of 2023 to 4% of total M&A activity.
Buyers are turning in growing numbers to low and mid-market deals of under $100 million. This is particularly true of Private Equity firms, who are using their huge stash of dry powder, estimated at more than $3 trillion (about $1.1 trillion in the U.S.), to buy smaller companies, often as plug-ins to other companies in their portfolios.
As evidence of this trend, The Wall Street Journal reported that PE-backed deals in the first half of 2023 averaged $65.9 million, the smallest value for a six-month period in years.
What’s driving lower mid-market activity?
Tim Goddard, Corum's Executive Vice President of Corporate Strategy, points to a number of factors driving PE activity in the mid-to-lower range of the M&A market.
Rising interest rates
One factor is rising interest rates. Goddard notes that higher interest rates means money is less easily available to investors, and because of that, bigger deals are harder to do. "It just takes less money to buy smaller companies," Goddard says, "and that pushes people down market."
PE history
Another factor noted by Goddard is the history of PE firms, which often start by finding success with investments in small or mid-size companies. They find success in these lower-middle markets because, as Goddard points out, “It's much easier to build a small company into a medium company or a medium company into a large company, then it is to build a large company into a larger company at the same rate.” He continues, "You can increase your return if you're able to do small deals at volume and double the size of all of those companies over a period of time. That's a big “if”, but if it works, it’s a faster way to double your money than trying to do the same thing with an already billion dollar company."
Over time, as PE firms grow, they typically turn their attention to bigger deals. But they don't lose the insight that doing small deals at volume is a good way to get high returns. In fact, PE firms often return to their roots by setting up sub funds specifically designed to invest in small-to-mid-size companies, companies that are too small to be investment targets for their larger funds. One example of this is Vista Equity Partner’s Endeavor Fund, which focuses on lower middle-market enterprise software, data, and technology-enabled companies.
Additionally, people who have done deals in the lower-middle market sometimes leave firms that have moved up market, and start their own independent funds specifically focused on the lower-middle market. The growing number of both varieties is driving a lot of activity in the lower end of the market.
The buy-and-hold model
The high activity and success that PE firms are finding in smaller company acquisitions are also spawning a crop of imitators. This is especially true of buy- and-hold acquirers. The exemplar of the buy-and-hold model is Constellation Software, a company that buys software companies and holds on to them for the long term. Constellation's approach, as well as many other holding companies, is to essentially leave the acquired companies alone and harvest the cash flow. But there's also a new breed of buy-and-hold companies more focused on growing the companies they purchase. Goddard says these acquirers follow the buy-and hold-model, but they push for growth. "They're putting money in initially, rather than taking it out,” adds Goddard. "And they're seeing good success in doing that with the idea being that cash flow will take care of itself with growth.” These buy-and-hold acquirers are also a factor in the high activity at the low-to-mid range of the M&A market.
Bolt-ons and roll-ups
Another factor creating more lower-middle market activity is the PE-driven bolt- on strategy, where these firms add smaller companies to a platform company in their portfolio. In 2022, PE firms did nearly eight bolt-on deals for every platform deal. The ratio of 7.6:1 bolt-ons to platforms set a new record, far exceeding the ratio of 5.4:1 in 2021 and 4.1:1 in 2020.
A recent example is the purchase of Corum client Gazelle.ai, an artificial intelligence-based business intelligence platform, by labor market analytics company Lightcast, a portfolio company of multi-billion dollar PE firm KKR. Typically KKR's investments are in large companies, often in the billions of dollars. However, the purchase of Gazelle.ai is a bolt-on of a small company to their platform company Lightcast. The intent is to combine Lightcast's business information and Gazelle.ai's labor analytics to produce valuable insights for economic developers.
Over the last decade Goddard has seen financial buyers acquire almost any size company ‒ no matter how small ‒ if it fits their bolt-on strategy. "It used to be that $10 million in revenue was the target for Private Equity firms, and then five was the new 10, and then three was the new five," says Goddard. He adds that today there are companies willing to go as low as $1 million in revenue or sometimes even lower for stand-alone acquisitions.
Although less frequent that bolt-ons, roll-ups are also being pursued by PE firms in today's market. In a roll-up an investor such as a PE firm buys companies in the same market and merges them together more or less at one time. Roll-ups are yet another way in which PE firms are buying lower market companies. An example of a roll-up is PE firm TA Associates' purchase of Corum client VIA Information Tools, a manufacturing execution system software provider. TA combined the VIA purchase with acquisitions of five other companies: Advantzware, DDI System, Distribution One, InfinityQS, and Kiwiplan, to form Advantive, a company that offers enterprise resource planning (ERP), manufacturing execution systems (MES), and statistical process control (SPC) software solutions for specialty manufacturers and wholesale distributors.
According to Goddard, roll-ups are more challenging to implement than bolt-ons because they involve merging a lot of moving pieces together at essentially the same time. However, he notes they both are ways that larger financial buyers can justify buying smaller technology firms.
Now is the time to test the market
With all the current acquisition attention paid by buyers to the low-to-middle market, now is an excellent time for smaller tech companies to pursue an M&A, especially with an experienced M&A advisor like Corum. With nearly 40 years of proven success and more than 500 deals closed ‒ primarily in the lower middle market ‒ Corum provides the experience, expertise, and proven process to put you in position for an optimal offer. At the very least, pursuing an M&A process with Corum will calibrate what your company is worth in the current market. In addition, Corum's team of experienced CEOs who have run, sold, and bought companies will help you present your company in the best possible way to potential buyers. There is a ready market right now for acquiring small-to-mid-size companies. Now is the time to take advantage of it.