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Federal Market Intelligence for Small Business |
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Column: M&A for Small GovCons: Are We In or Out?By Sharon B. Heaton, CEO & Scott E. Semple, senior advisor, sbLiftOffThe appetite for merger and acquisition (M&A) transactions is surging as the world emerges from the economic depths of the Covid-19 pandemic. According to data provider Pitchbook, in the first half of 2021, 67% of all private equity deals in the U.S. were under $100 million in size. Business-to-business, IT and healthcare were among the most active sectors, comprising almost 70% of activity. The pace shows little signs of slowing down. A potential capital gains increase is spurring privately-owned businesses to sell several years earlier than expected. Low interest rates make the cost of financing attractive for buyers looking to acquisitions to grow and scale their businesses. Another major tailwind is the significant amount of private investment capital that has been raised over the past few years to invest in companies. So are small government contractors IN or OUT of the M&A feeding frenzy? The answer is a resounding--yet qualified--IN. Small and mid-cap govcons are buoyed by the same general market trends mentioned above: cheap money, looming capital gains and lots of smart investors sitting anxiously on the sidelines. In addition to these broader trends, the maturing of the four categories of the set-aside marketplace during the past 20+ years has resulted in a number of factors leading to accelerated M&A activity. CLEAR AS MUD: Laws, Case Law, and Fed Policy Federal laws and acquisition policies set a goal of allocating 23% of all discretionary acquisition to small businesses, along with goals for Small Disadvantaged, Women-Owned, HUBZone, and Service-Disabled Veteran-Owned small firms. While these laws and regulations initially were viewed as ‘restrictive covenants’ that could complicate mergers and acquisitions, they progressively have been tested in the Court of Federal Claims and other venues, resulting in a body of case law clarifying the sometimes murky rules. The result? To those with the patience to read these legal tea leaves, there are clear pathways to guide even the most complicated set-aside M&A transactions to a successful close. And federal agencies have adopted business-friendlier policies to evaluate small firm acquisition and contract novations based upon this body of case law. This has resulted in a very active pool of buyers scouting the market. SMART SELLERS: M&A Is a Core Business Growth Strategy The post-WWII surge in small business creation resulted in hundreds of thousands of ‘family-owned” firms that tended to stay in families for generations. Today’s entrepreneurs bring different skills and very different expectations to business ownership. These creative founders/owners begin with a solid base of core competencies, including an ability to navigate federal set asides as a market entry technique. They expand using organic vertical and horizontal business growth techniques and have increasingly explored and leveraged Joint Ventures, Teaming, Mentor/Protege agreements and other nuances supported by agency policies. In addition, the last decade has seen a surge in small government contractors that view M&A as a core part of enterprise growth, recognizing and leveraging market trends to achieve scale and diversity in fast-moving federal markets like cybersecurity, artificial intelligence, logistics and health care delivery. As a result, many small business owners now enter the government market with the idea that they will eventually sell their company. In fact, companies thinking about a sale are often in a great position to buy as part of their strategy. These firms are well positioned to acquire or to be acquired in the quests for first-mover advantage, avoiding small firm stagnation, and providing the ability to slingshot into the full and open marketplace with momentum. SMART BUYERS: Success Breeds More Success A primary factor driving the success of any acquisition is deep industry knowledge. Buying a diner? You had better know the restaurant trade inside and out. The same goes for federal small business set aside firms, and the pool of experienced business leaders with skills, market knowledge, hands-on experience, and funds has grown exponentially. Over the past 20 years, the number of small business entrepreneurs that have entered the federal market by leveraging set-aside programs has ballooned. It is estimated that over 10% of the small federal contractors are serial entrepreneurs working on their second, third or sometimes fourth startup. What has all this activity yielded? Two primary sets of smart buyers: 1) seasoned entrepreneurs who climbed the set- aside ladder to execute their exit strategy through a liquidity event, and are now ready to deploy their own funds back into a post-startup firm they can relaunch using their knowledge and connections; and 2) private equity firms, angels, and other funding sources with experienced advisors specifically focused on the government contracting set-aside markets and ready to pounce when they identify the right firm that matches their portfolio criteria. SMART ADVISORS: To Close the Deal: So it sounds like all you need to do as a buyer or a seller is hang out your “For Sale” or “Buying Small GovCons” sign and the deal is done, right? Wrong. According to a recent article in the Harvard Business Review, as many as 9 out of 10 business ‘deals’ in the small and mid-market never close. Part of the reason is that rarely does a Do-It-Yourself approach work – between legalities, transaction financing and document preparation, closing an M&A deal is complicated. Another issue is human factors. Developing the depth of trust and transparency that is required to close a business transaction is not a school-taught skill set. Managing buyers’ and sellers’ emotions along with schedules, Letters of Intent and term sheets is a big part of the challenge. Long ignored by the big firms, small business set-aside federal contractors are a primary focus of several new-age M&A firms equipped to get the deal done. The federal small business set aside market provides entrepreneurs the means to enter government contracting. How you exit is up to you, and your future is brighter than ever. Understanding how M&A factors into your game plan is a key success factor in FY2022 and beyond. For further information or assistance please contact Scott Semple at ssemple@sbliftoff.com or visit http://www.sbliftoff.com.
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