What distinguishes exceptional dealmakers in today’s M&A landscape? The ability to understand, anticipate, and navigate economic dynamics with clarity and confidence.
This skill has become particularly crucial in light of recent monetary policy shifts – we’re looking at you Federal Reserve – especially for owners and founders who are ready to transition ownership of their businesses or grow through acquisitions.
What Does the Interest Rate Cut Mean for My Business?
After much hand-wringing and speculation, on September 18 the Federal Reserve announced an interest rate cut, reducing rates significantly by 50 basis points with the hopes tamping down recessionary fears, this being the first rate cut in 4 years.
The result? There is increased excitement for founders and owners in the lower middle market as this rate is set to stimulate economic activity and create more favorable conditions for business transactions.
Lower Middle Market Resilience: Opportunities Amid Shifting Dynamics
The M&A landscape has undergone significant shifts since 2020. Initially fueled by post-pandemic stimulus measures, dealmaking and asset prices boomed through 2022. However, this era ended abruptly as the Fed’s aggressive interest rate hikes to combat inflation, coupled with increased regulatory scrutiny, led to a slowdown in deal activity across many sectors.
Despite these challenges and negative headlines about megadeals, the lower middle market tells a different story. This segment continues to experience increased activity, buoyed by recent interest rate cuts.
Private equity firms are showing renewed interest in quality, well-run businesses in this space, viewing them as attractive and less risky acquisition opportunities. Additionally, lenders specializing in smaller transactions are more willing to provide capital, potentially offering buyers more favorable financing terms. Businesses poised to seize opportunities with the right advisory team by their side stand to gain the most.
The Advantage of Proprietary Deal Flow
Proprietary deal flow plays a crucial role in facilitating strong deals, especially in an inflationary environment. At the core of high-performing M&A activity, it creates exclusive acquisition opportunities available before they reach the broader market. Essentially, proprietary deal flow is about accessing and acting on deals before competitors even know they exist.
By leveraging exclusive access to potential acquisitions, companies can identify and secure high-quality targets before they hit the open market, often at more favorable valuations.
This approach not only reduces competition but also allows for more thorough due diligence, enabling buyers to better assess how inflation might impact the target’s operations and future performance. Consequently, proprietary deal flow becomes an even more valuable asset in inflationary times, helping businesses execute strategic add-ons and roll-ups that can effectively combat rising costs and maintain competitive advantage.
The Power of Exclusivity
Proprietary deal flow is highly prized in lower middle market M&A world for several reasons:
- Reduced Competition: When you have exclusive access to a deal, you’re not competing against multiple bidders, which can lead to more favorable terms and pricing.
- Better Due Diligence: With less time pressure, you can conduct more thorough due diligence, reducing the risk of costly surprises post-acquisition.
- Higher Success Rates: Deals sourced through proprietary channels typically have a higher likelihood of closing.
The Return of the Platform Acquisition Coupled with Proprietary Deal Flow
The recent interest rate cut is set to revitalize platform acquisitions in the lower middle market, while simultaneously highlighting the importance of proprietary deal flow. As borrowing costs decrease, private equity firms are showing renewed interest in establishing and expanding platform companies, particularly through the “buy-and-build” strategy.
This strategy, where investors acquire a core business (the platform) and then pursue add-on acquisitions, is becoming more financially feasible due to lower interest rates. However, success in this competitive landscape increasingly depends on proprietary deal flow. This approach not only allows firms to identify ideal platform companies but also facilitates strategic add-ons at potentially more favorable terms.
While add-on acquisitions remain crucial for value creation and growth, the current environment is rekindling interest in larger platform deals. The combination of renewed platform acquisition activity and the continued importance of proprietary deal sourcing is creating a dynamic market in the lower middle market. This shift offers opportunities for both buyers and sellers, but success will likely hinge on the ability to identify and act on deals before competitors even know they exist.
Characteristics of a Strong Platform
- Solid Market Position: The company should have a strong foothold in its industry and a diversified customer base
- Scalable Infrastructure: Businesses with systems and processes that can support significant growth.
- Strong Management Team: A capable leadership team is crucial for executing the post-acquisition strategy.
- Growth Potential: The platform should have clear opportunities for organic growth and synergistic acquisitions.
The Platform Strategy in Action
Once the platform is acquired, the strategy typically unfolds as follows:
- Operational Improvements: Enhance the platform’s operations and profitability.
- Add-on Acquisitions: Identify and acquire smaller companies that complement the platform.
- Integration: Carefully integrate add-ons to realize synergies without disrupting operations.
- Repeat: Continue this process to build scale and expand market presence.
Strategic Next Steps with REAG
Several key strategies emerge for success in the lower middle market:
- Leverage Proprietary Deal Flow: Access exclusive opportunities before competitors, leading to better valuations and higher success rates.
- Embrace Platform Acquisitions: Capitalize on lower interest rates to establish and expand platform companies, particularly through “buy-and-build” strategies.
- Combine Strategies: Integrate proprietary deal sourcing with platform acquisitions and strategic add-ons to maximize growth and value creation.
- Stay Adaptable: Remain responsive to economic shifts, such as interest rate changes, to seize opportunities in a dynamic market.
- Partner with Experts: Align with advisory teams that understand the nuances of the lower middle market and can guide you through complex transactions.
REAG stands ready to empower your business with these transformative M&A strategies. Our expertise in proprietary deal sourcing, platform acquisitions, and efficiently rolling up strategic addons can help you navigate this complex landscape. We tailor our approach to your unique goals and market conditions, maximizing your potential for success.
If you’re prepared to write the next chapter of your business journey, leveraging these key M&A strategies, reach out to REAG.
