5 Predictions for Middle Market M&A in 2014

With 2013 ending on a high note for many deal professionals, the forecast for 2014 is generally favorable. Growing economic confidence, favorable lending environments, and continued IPOs would satisfy most soothsayers.

Because of these positive trends, and growing demand for competitive advantage, 2014 will likely see the culmination of some larger-scale trends in the middle market. Using insights from Axial Members, data from the network, and general market trends, here are 5 predictions we expect to be realized in 2014:

Prediction #1: The Lower Middle Market Will Dominate M&A Activity

According to a recent survey by KPMG, 2014 will be a year dominated by lower middle market activity. As the survey learned, “Seventy-seven percent of respondents expect their respective deal activity will be valued under $250 million, followed by 12 percent who anticipate their acquisitions will be valued between $250 and $499 million, and five percent between $500 and $999 million.”

While the lower middle and middle markets traditionally see the greatest number of deals, 2014 could have particularly concentrated activity in these markets. With the 2008 financial crisis now five years in the past, many businesses are now able to build effective and promising books. Baby boomers and business owners on Main Street will likely take the rising optimism and improving economic conditions in 2014 to bring their businesses to market before the next down cycle. While mega-deals may appear occasionally, most checks will be written for sub-$500 million.

Prediction #2: For PE Firms, a Business Development Partner Becomes the Best Practice

Over the past several years, the role of the private equity business development partner has become increasingly important for private equity firms — a trend that will only accelerate in 2014.

As middle market investment banking continues to fragment, the firms with dedicated business development efforts will be positioned to realize deal flow of greater quantity and better quality. With a business development professional sourcing deals by cultivating strategic relationships, these firms will gain a competitive advantage through the depth and scope of their relationships. In addition to the more robust deal pipes, firms with BD professionals will be able to spend greater time optimizing and growing their portfolio companies.

New fundraising in 2014 will also encourage greater adoption of the business development professional. “While [firms] see the value of having a deal sourcing specialist, they have a hard time dividing up economics midway through the investment period,” explained Wayne Sills. As fundraising efforts begin anew — and firms look to spend their dry powder — in 2014, many firms will be looking to the BD model.

Prediction #3: Boutique Bankers Increasingly Adopt Social Media and Blogging to Differentiate Their Expertise

Another way deal professionals will source new deals and develop a competitive advantage in 2014 will be through the use of online blogging and social media. Encouraged by the recent lifting of the ban on general solicitation — and now far enough removed from the 2012 presidential campaign that severely tarnished the reputation of private equity firms — deal professionals are in a unique position to proactively offer transparency into the industry.

Whether it is forms of blogging or social media, the online presence and transparency could bring private equity and financial sponsorship to the attention of many business owners and baby boomers looking to exit at the top of their cycle. But they will have to do it carefully and eliminate the jargon when speaking with non-industry professionals. Financial Technology Partners and Berkery Noyes are already making progress in this area.

Prediction #4: Industry Specialization Will Help PE Firms Beat Strategics

Strategic acquirers are entering 2014 in a particularly advantageous position. Between their large cash reserves and rising stock prices, many strategics will be able to outbid most financial sponsors in an auction process. While there are a couple of strategies for a financial buyer to outmaneuver a corporate acquirer, specialists will be best equipped to challenge a large strategic acquirer in 2014.

As many baby boomers look to retire, they are seeking more than just capital. “I really believe that most of these retiring entrepreneurs want more than a simple check; they want a real transition with real mentorship…they want succession,” explained Benjamin Gerut of Kuzari Group LLC. Audrey Smith of Cowen agreed with Gerut’s assessment. She has learned, “Most entrepreneurs are looking for partners — someone that can help them grow, not just provide capital. I think many of these owners learned during the recession that having money can’t get you all the way there.”

Since corporations rarely offer partnerships, specialist financial sponsors can offer this unique benefit. Demonstrating clear knowledge of a company, understanding of a market, and interest in partnership can be extremely appealing to the Main Street entrepreneurs that have never previously engaged with institutional capital.

Prediction #5: Family Offices Will Become More Accessible to SMB Owners

Over the past several years, many family offices have begun directly buying or investing in private companies — another trend that will accelerate in 2014. In the last 12 months, there has been a 50% increase in the number of family offices actively pursuing private company investment opportunities on Axial. Additionally, those family offices are becoming more active — meaning they are looking at and pursuing more opportunities.

“Although many more family offices are looking for private investments, many are hesitant to invest in PE firms because they do not see the benefit of the structure,” Romanow explained. “If you are capable of directly investing, the idea of fees, the illiquidity of the fund, the lack of control, and the desire to quickly sell the winners and hold the losers is not appealing,” explained Howard Romanow. Fearing the volatility of the public markets and dissatisfied with the expensive illiquidity of PE firms, many offices have endeavored to deploy their capital with in-house guidance.