Fortune Hunting — Why Would Any Owner Give Up Their Company, Position, and Power?
By Mike Paparella & Brian Milligan
Universal Advisor, 2006 Issue No. 2

From an outsider’s perspective, many owners of middle-market companies enjoy a status not experienced by most other workers. They tend to earn above average pay; occupy a revered position in the community; have no boss or board that holds them accountable; are seen as leaders with valued opinions by their staff, customers, suppliers, and circles of friends; and tend to have some flexibility in their schedule that allows them to strike a good balance between their work and personal lives. Why would anyone trade that for something different?

According to Thomson Financial, more than 1,400 company owners in Illinois, Michigan, and Ohio reported more than 141 billion “reasons” to sell their companies in 2005. Many of these owners determined that either company performance and/or market conditions for middle-market M&A supported selling all or parts of their companies. M&A activity nationally and within those three states has been on the rise since 2002, and data from Thomson indicates that 2006 results will show further increases in activity, as revealed in Table 1.

PMCF analyzed the reported transaction data among these three states against comparable national transaction data. Interestingly, these so-called rust belt states, which account for 12 percent of the nation’s population, accounted for 14 percent of the nation’s reported transaction value and approximately 19 percent of the nation’s reported transactions.

A look at Table 2 highlights the fact that the majority of M&A activity in that three-state area is initiated by companies headquartered there (compared to intra-area businesses being acquired by “outsiders”). This finding likely comes as a bit of a surprise as it implies a general “healthiness” of companies headquartered in those states in that there are more buyers than sellers. The reason for the surprise is that many market analysts note that companies in the “rust belt” are the most likely to lose the war on cost and, therefore, will simply cease operations, move their businesses overseas, or sell to an international player that acquires customers and moves the manufacturing to one of their lower-cost facilities outside of the state or country. While some of that is certainly taking place, it appears that a number of acquiring companies in various industries are growing through acquisition, and the selling companies are realizing values strong enough to convince them to sell.

Indeed, merger and acquisition conditions in most industries today are very favorable to sellers. Factors contributing to these favorable conditions include:

• Relatively good economic conditions in the United States.
• A “hangover effect” felt by private equity firms needing to get their funds invested after many buyers “sat on the sidelines” during the M&A market downturn from 2001 through 2003.
• A large and growing population of private equity funds and hedge funds competing for acquisition opportunities.
• Favorable advance rates from lenders, enabling bountiful leverage to be placed on a company, thereby minimizing the invested equity and increasing a fund’s projected returns.
• Reasonable interest rates from debt providers of all types.
• Improved performance reported by companies over the past two to three years, indicating increased value requirements.
• Consolidation among major companies making headline-quality transactions, igniting M&A excitement downstream among owners of middle-market companies.

These attributes have renewed the interest on the part of company owners considering ways to capitalize and monetize their potential “fortunes.” Many of these owners experienced a sharp devaluation of their businesses from 2001 through 2003, driven by the overall downturn in the economy and a generally negative M&A environment, as many of the attributes described above turned against sellers. Now that recent market activity reflects a return to a generally positive M&A environment, new exit alternatives are gaining popularity that enable company owners to take a bold approach in pursuing their fortunes, while maintaining their relative positions in the companies and the community. This frequently comes in the form of an equity recapitalization of the business, where the owner sells some percent of the company (generally ranging from 40 to 80 percent) while holding on to the remaining shares and continuing to lead the company through its next phase of growth. This way, the owner locks in value during favorable M&A conditions, while still enjoying the qualitative benefits of being a company owner.

Other company owners might find their fortunes by selling their entire companies and locking in total value. Still others will pursue the path of holding on to their companies and growing them organically or through acquisition during the most active M&A cycle since 2000. Which path of fortune will make you better?