Corporates still hungry for SME acquisitions

Why spend on R&D when acquiring a ready-made, smaller company can provide the product, service, technology, team or market your company requires?

And in less time and for less money. This seems to be the perspective of the bigger corporate entities in the business world today who are increasingly competing to buy up successful - or potentially successful - smaller enterprises.

This is one of the main takeaways from recent research carried out by law firm Bond Dickinson, which examined the trends in corporate deals involving UK small and medium enterprises (SMEs) between April 2013 and April 2017.

Some 5,447 deals were carried out in this period with a total value of £102 billion. To put that in perspective, this sum far exceeds the £62 billion that large organisations spent on research and development in the same period, and represents more than a seventh of the £683 billion that was invested in UK businesses.

Though recent macroeconomic pressures have contributed to a 28 per cent fall in deal volumes in 2016/17, general business investment too. The impact of Brexit and uncertainty in UK politics after the Theresa May’s government failed to secure a majority in the 2017 General Election, have made deals that bit harder to make. A 1.5 per cent downturn in investment recorded in 2016 by the ONS was the first contraction seen since 2009, and growth this year has continued to lag behind the recovery of GDP.

This trend appears to be short term, however: according to business accountants BDO’s quarterly Private Company Price Index, there were 9.5 per cent more deals in Q2 2017 than there were the previous quarter, with market valuations for companies also rising in that time.

A closer examination of Bond Dickinson’s research, entitled ‘Close Encounters: The power of collaborative innovation”, shows that lag in 2016-17, large organisations still invested £21 billion in 1,111 deals with UK SMEs in the tax year 2015-2016. This is 31 per cent more than the total amount invested in research and development. Of these deals, 55 per cent involved M&A in some capacity.

For those buying and selling businesses, this is clear evidence that acquiring a complementary SME can be of value to all parties. It might be a clever move to buy, grow or consolidate a portfolio of different businesses with the strategic aim of building an attractive acquisition target for corporates. The advent of start-up culture, where small teams can often develop market-defining ideas with relatively little initial capital, provides a unique feeding ground for larger companies seeking talented teams.

David Dale, head of private wealth and entrepreneurs sub-sector at Bond Dickinson, says start-up firms can be “perfectly designed” to develop new ideas but typically lack the market reach, regulatory know-how and financial muscle to achieve their full potential.

He added: “Corporates, on the other hand, struggle to turn their R&D investment into innovation from within. The combination of the two is a powerful one.”

With this in mind, what type of companies are going to be the top targets for these corporate acquirers? Are there certain industries or sectors that are favoured?


When it comes to which smaller companies are particularly attractive, these are hard questions to answer. EY’s sector-lead analysis of M&A deals suggests that activity is particularly strong in the automotive and transport industry, where larger players are aiming to pick up innovative technologies from smaller firms, and the consumer and telecoms sectors, where market consolidation is in full swing.

According to Clifford Chance’s latest review of the global M&A market, deal activity is highest in Europe, with an increasing proportion of deals originating from acquirers in North America. Germany and Spain are two driving countries for deal volume, though previous appetite from Chinese corporates for making deals has slowed down.

There are of course factors that will render SMEs that bit more attractive to large corporate acquirers, most of which centre around a firm’s potential value, profitability and stability.

According to The Attractive M&A Targets Report, conducted by Intralinks and the Cass Business School, the key factors are sixfold: a company’s recent growth, profitability, a high debt to EBITDA ratio (a measure of well leveraged a company is), typically an above-average size (in terms of sales volume), lower liquidity and lower valuation multipliers (usually measured by enterprise value to EBITDA).

This science is imperfect however, and the report’s aim was to shed light on previous deals - not those that might be happening tomorrow.

According to Bond Dickinson’s data, the financial services industry is beyond all other sectors in terms of both the volume and value of deals done with SMEs. Larger financial services firms made 1,864 deals with SMEs over the past four years, pumping £31 billion into such firms. This made up 34 per cent of the UK’s total deal volumes in that time; by comparison, financial services and insurance firms account for 7.2 per cent of the UK’s GDP.

Big banks are less likely to make full acquisitions or even joint venture deals with SMEs, however, with three in four deals that Bond Dickinson recorded in the sector structured as minority stake purchases. This often represents the way that large banks partner with fintech startups, say the report’s authors, and may be a way in which other large acquirers seek to do their M&A business going forward. Data shows the insurance sector is heading the same way.

One thing that is certain - and one thing that is good news if you are in the business of buying and growing small companies - is that the UK M&A marketplace favours the seller at present. According to BDO’s Index, along with a 9.5 per cent uplift in deal volumes there was also evidence that investors are paying an increasing premium for UK businesses, with the average private equity deal worth an average multiple of 12.8x (a measure of value vs company EBITDA).

Despite the recent macro-economic pressures that face the UK, and which may well continue to reverberate for some time, the M&A market is in rude health thanks to the strength of private equity funding, flexible debt markets and cash-rich companies, which in turn means there are far more companies hoping to make acquisitions than there are businesses for sale.

“This is creating a seller’s market, where competition for quality businesses is driving attractive valuations for vendors”, write the BDO report’s authors. The main challenge, they continue, is for investors and larger corporates to find the M&A targets that are right for them.

With such renewed hunger for M&A from the corporate world, there are even more reasons to find, nurture and grow promising businesses that may one day be ripe acquisition targets. With over 600 deals completed in the last quarter of the year alone, buyer confidence in the UK’s SME market is in no danger of drying up.

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