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Know Your Company’s Market Position before Embarking on M&A Activity

If you’re thinking about chasing acquisitions or selling your business or merging with another, understanding where your business fits in the market is important. The distinction has to do with size, revenues and profits.

Then you have the issue of critical mass. Critical mass is a subjective term, and it simply means size: Does the company have enough employees, revenues, management depth, clients, and so on to survive a downturn?

Smaller businesses most often do not have enough critical mass to be of interest to acquirers. Capital providers who may be able to help finance acquisitions will have little or no interest, too.

Although critical mass differs for different companies, in a general sense a company with $30 million in revenue and $3 million in profits has a better chance of surviving a $1 million reduction in profits than a smaller firm with only $500,000 in profits.

Definitions vary, but for all practical purposes, you can divide the market into sole proprietorship, small business, lower middle market company, middle market company, and large company (and beyond).

Company Type Annual Revenue M&A Advisor Number of US Companies
Sole proprietorship Less than $1 million Business broker 6 million
Small business $1 to $10 million Business broker 1 million
Lower middle market company $10 to $250 million Investment banker 150,000
Middle market company $250 million to $500 million Investment banker 3,000
Large company (and beyond) $500 million+ Bulge bracket investment banker 3,000
Source: Census Bureau

Sole proprietorship

Sole proprietorships are companies with revenues of less than $1 million. They’re your neighborhood pizza joints, corner bars, clothing boutiques, or small legal or accounting practices.

Although these businesses are viable going concerns (aren’t facing liquidation in the near future) and often trade hands, they’re too small to be of interest to PE firms and strategic Buyers, as well as corresponding service providers who assist in M&A work.

Why are sole proprietorships of little or no interest to an acquirer? Simply put, buying a $1 million business and a $100 million business requires about the same amount of time and the same steps and expenses, so if you’re going to go through the trouble of buying a company, you may as well get your money’s worth and buy a larger concern.

Small business

Small businesses usually have annual revenues of $1 million to $10 million. These businesses are larger consulting practices, multiunit independent retail companies, construction firms, and so on. Unless the company is incredibly profitable (profits north of $1 million, preferably $2 million or $3 million), small businesses are too small to be of interest to most strategic acquirers and PE funds.

Although PE funds and strategic acquirers are usually not interested in smaller companies, they occasionally make exceptions if a company has a unique technology or process. In these cases, the acquirer can take that technology or process and deploy it across a much larger enterprise, thus rapidly creating value.

Middle market and lower middle market company

Lower middle market companies are companies with $10 million to $250 million in annual revenue; middle market companies have revenues of $250 million to $500 million. These companies typically have enough critical mass to be of interest to both strategic acquirers and PE funds. Also, because these deals are larger than small business and sole proprietorship deals, M&A transaction fees are large enough to justify the involvement of an investment banking firm.

Large company (and beyond)

Companies with revenues north of $500 million are considered large, huge, gigantic, and, if revenues are well into the billions, Fortune 500. Although transactions are typically very large, the fact is very few companies are large. The middle and lower middle markets are far larger.

Firms in this category typically use bulge bracket investment banks. These entities are the largest of most sophisticated of investment banks. They also charge enormous fees.

The term bulge bracket originates from the placement of a firm’s name on a public offering statement. Public offerings of securities typically involve multiple firms, and the largest firms, or managers of the offering, want their names to the left, away from the names of the smaller firms. The placement of the names looks as if they were bulging, hence the moniker.

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