Survey Shows Mid-Market Bullishness –

The results of a soon-to-be-released survey by the Association for Corporate Growth and Thomson Financial, publisher of Buyouts, reveal an optimism in the middle market that has been lacking in recent years. Among other things, the survey showed that 90% of overall respondents and more than 83% of private equity respondents expect their companies to grow revenue this year, while 85% of all respondents expect a jump in M&A activity.

“From corporations to private equity firms to banks, and from small-market to billion dollar companies, there is optimism about the environment for corporate growth and dealmaking in 2004,” said Charles Downer, CEO of Downer & Co. LLC, who just stepped down as president of ACG. “This tells me that two major stumbling blocks to recent deals -economic uncertainty and disagreement on valuation-are receding and we may see a significant pickup in activity.”

One potential negative for buyout firms is the forecast of higher valuations, which two-thirds of respondents are predicting. While buyer and seller expectations are clearly more in line than they were a couple years ago, 58% of survey respondents said disagreement on valuation is still the most common reason why an acquisition fails, followed by economic uncertainty (19%), and inability to secure acquisition financing (14%).

More specific to buyout firms were the results on issues like deal sourcing, due diligence, and who’s actually doing the work in these areas. Among those private equity firms who took the survey, nearly half source their deals primarily through an intermediary, while 42% cited that method as the most effective means through which to find deals.

“The good news is you’ve got a motivated seller. The risk of seller remorse is decreased when you use an intermediary, and you probably have access to more information and you’re not going waste a lot of time,” said Jay Jester, a senior vice president at Audax Group. “The bad news is [using intermediaries] is an efficient process for the sellers too. Everybody gets to see the deal, and whoever shows up with the most cash wins.”

Indeed, for some firms-especially those with conservative spending habits-the auction process has been a major source of frustration, since the presence of multiple bidders usually jacks up the target’s asking price. That helps to explain why, according to the survey, 26% rely more heavily on cold calling, a trend that has grown considerably over the last couple years.

The survey showed that buyout shops will either call potential targets directly or build their contact base through attending conferences and networking events. These two methods that together were cited by 34% of respondents as the most effective way to source deals. Perhaps more interesting is the fact that it’s not just the low-level staffers making cold calls; at 54% of firms, it’s the partners working the phones, while at 16%, people at every level participate.

While cold calling affords the caller greater exposure among potential sellers, the method does not necessarily ensure greater deal flow or, for that matter, better deals. Brian Conway, a managing director at TA Associates, which has been cold calling long before it became fashionable, said, “We can contact hundreds of companies, and the majority aren’t interested in talking to us. Price expectation is always an issue. Companies want more, and there isn’t any room for error these days because there is so much competition [among the buyout shops].”

Others in the private equity universe prefer to fall back on a reliable pool of contacts to source deals. Jamie Elias, a director with Trivest Partners, said, “For us, the most successful strategies we’ve found is to keep close relations and constant dialogue with people that deal with these companies on a daily basis, such as lawyers, accountants and our network of CEOs. Conferences are very good to keep our contact base current and ensure our name is in front of people that are in the marketplace.”

Due Diligence

The survey also touched on due diligence, always a relevant issue but particularly important at a time when buyout shops need to spend but at the same time can’t afford to deploy too many man-hours on a deal they may not end up winning.

According to the survey, private equity professionals aren’t leaving much to chance. Almost 72% of respondents said they have the lead partner on the deal and his or her team conducts the due diligence themselves. Only 15% give the job to an associate, while eleven percent hire a consultant to do the work.

“We do most of the due diligence ourselves. Our impression is that some of the bigger buyout firms use a Bain or a McKinsey,” said Conway. “We will bring in KPMG or PwC when we want to comb through accounting issues and they may give us their view, but we really do our own work and make our own decisions. We make the phone calls rather than hiring a Bain.”

Patrick Hurley, a principal with investment bank MidMarket Capital Advisors, said, at the end of the day, the due diligence comes down to the person who is accountable for the deal. “If you’re the person responsible for the deal, you have to have a good understanding of what is going on, and you figure that out by being involved,” he said.

The survey also addressed ways in which the target company presents hurdles for buyout shops. Not surprisingly, an unwillingness to give up ownership was the most commonly cited obstacle.

“A lot of it is a control issue,” said Elias. “Many times an owner wants to sell a stake, but maintain the majority role.”

When trying to obtain financial information, survey respondents said the biggest problem is how poorly it is organized. The second biggest impediment is simply getting a business to provide financial information.

“There’s a perception that small businesses or family-owned businesses don’t want to give up their information, but it is more a case of disorganization,” said Hurley. “Sometimes it is because the information is tied to the owner. He doesn’t want everyone knowing his business and then having the buyout firm not even use the information it obtained. It is common for a buyout shop to not take the time to find out what they want, ask for everything and not even use it.”

More About the Survey

A press release with the full results of the survey will be posted at on Tuesday, Jan. 20. Conducted in December 2003, it was completed by 1,300 Thomson clients, readers of Thomson publications (like Buyouts), and members of ACG. Some 27% of respondents were corporate executives; 21% were from buyout, private equity and venture capital firms; 28% from investment banks, intermediaries, and commercial banks; and 21% from law, accounting and consulting firms.