Founder-Owned Businesses Are Attractive M&A Targets

According to a recent Pitchbook report, buyers favor non-backed private companies in today’s M&A market. Non-backed companies are defined as not receiving any outside capital from private equity, venture capital backers, or angel investors.

The report says that the total investable universe of non-backed private companies, including those with over 20 employees, is around 2.6 million in the U.S. and Europe, growing by approximately 50,000 annually on a net basis. With such a large volume and a wide variety of non-backed companies, the pool is full of attractive targets for acquisition by corporate and sponsor buyers. Meanwhile, the number of private-equity-backed platform companies acquired has only grown by 0.6%. 

• For the years 2007 to 2015, deals with non-backed sellers declined from 66% to 52.6%
• But, this trend turned around for the years 2016 to 2023, with these types of deals rebounding from 56% to 65.1%

Why Sponsors and Corporate Buyers Love Founder-Owned Businesses 

There are several reasons these buyers love founder-owned companies.

• It is often easier to create change and use expertise to transform them, making it easier to extract growth
• There is no previous funding from outside sources, giving the buyer a clean slate with no baggage or conflicting cultures
• They also have value-creation and business-scaling opportunities when buyers get in closer to the ground floor
• Many founder-owned businesses also carry very little debt on their balance sheets, making them more financially attractive targets
• Any existing debt can usually be swapped out for cheaper debt
• There is also a wider variety of companies to choose from in this segment, which makes it easier to fill a particular need or tap into a new niche 
• Founder-owned businesses are also usually much less expensive to buy 
• At a time when there are fewer willing sellers overall, the large number of founder-owned companies for sale is a significant source of inventory for hungry M&A buyers that are flush with cash and looking for deals
  

Market Conditions

Sponsors and corporate acquirers need help finding sellers because the exit market has slowed due to market dislocation between buyers and sellers. Private equity and venture cap owners are trying to hold out until there is an improvement in liquidity and valuations. Selling by large corporates has also slowed, extending a six-year slide in divestitures’ share of all deals from more than 20% in 2016 to less than 10% in early 2022 before bouncing back recently. Sponsors and corporate buyers are waiting for higher prices and a more favorable market for assets that are earmarked for divestiture.

Non-backed, privately owned businesses have always represented the largest share of the M&A market. They are in even greater demand now, which is excellent news for you as a private business owner. Another factor is that market conditions have made big deals more challenging to finance, causing deal sizes to shrink and chasing private equity firms and corporations further down the market. Elevated interest rates are also playing a role, causing sponsors and corporate buyers to invest in smaller, non-backed companies as an add-on basis as long as: 

• They remain promising for earnings growth 
• Financing for large platforms or strategic acquisitions continues to be scarce

Companies that are founder-owned make up the vast majority of non-backed companies. They are usually run by a handful of founding family members or employees and have zero, outside investors. Founder-owned businesses are often years in the making before they reach solid financial ground. Decision-making can lie with an individual or several generations of a family. These deals have fewer moving parts and less complexity than other ownership situations involving complexities such as stock and voting rights, proxy requirements, and regulatory issues. For these reasons, a fast-growing, founder-owned company is a buyer’s dream.

Founder-Owned Businesses by Sector

The B2B, B2C, and financial services sectors have the most purchases of founder-owned businesses. As of Q1 2023:

• B2B leads the way with 66.6% of the total deal count coming from non-backed businesses, as it is a very fragmented sector, which allows smaller companies to compete for market share
• Financial services followed at 63.7%
• And B2C followed at 61.7%
• IT was the sector with the lowest proportion of total deals from non-backed sources because tech has a solid private equity and venture cap presence

Bottom Line

Companies without backing have historically made up most of those sought after by major corporate and private buyers, but this has gained new momentum in recent years. This is because:

• The number of companies for sale is down
• Interest in founder-owned firms is up due to more focus on operational improvements to generate higher returns

This trend expects to continue as:

• Conditions become more challenging for founder-owned businesses, encouraging them to sell
• Assets of sponsor and corporate-backed companies stay on the sidelines, causing buyers to seek out non-backed targets even more