In the middle market, major transitions—such as a change in CEO, the acquisition of another business, the sale of the company, or some other event that significantly affects the leadership, financing, and future of an organization—are extremely common. More than three-quarters (77%) of middle market businesses have either experienced such a transition in the past five years or expect one in the next five years, while 54% say they fall into both categories. In other words, more than half of U.S. middle market companies can expect to face two major transitions in a decade.
That number may climb even higher in the near term, because of circumstances that create a “perfect storm” of business transition. First, baby boomers are at prime retirement age. Given that an estimated 40% of middle market companies are owned by boomers (and many others are led by them), there is a great deal of transition just waiting to happen.
Second, an enormous amount of capital is looking for a home— “dry powder” waiting to be invested. Prequin, a company that specializes in collecting data for alternative-asset investors, says private equity firms worldwide are sitting on more than $2.1 trillion in funds ready to be put to work. Third, low interest rates mean debt capital is cheap and easy to find—another incentive for acquirers. Fourth, owners, for their part, may be lured to sell thanks to near record-high valuations and prices. According to PitchBook, the median private equity deal closed for a price 11.1 times EBITDA last year—the highest multiple in more than a decade. For many owners, who still have vivid recollections of the last recession and valid concerns about the next one, there’s much more willingness to listen to solicitations that they once might have ignored. Those solicitations are literally pouring in: Executives tell us they get, on average, one to two inquires a month regarding the sale of their business.
Top prices and high rates of activity are good for sellers, and most executives say the transitions they have experienced have had positive results. Still, nearly half of all firms experience both positive and negative outcomes. Revenue growth and efficiencies are high on the plus side, but disruption of culture and employee or customer turnover can significantly deflate the results. Transitions not only affect the bottom line, they change things dramatically for the owners personally as well as for the employees who have helped them build their companies. Both the good and the bad, from both an economic and human perspective, need to be weighed carefully before pulling the trigger on any change.
The more companies prepare for transitions, the better results they get. This statement holds true regardless of the type of transition. Whether it’s a routine CEO handover, company sale, restructuring, or any other, middle market companies that consider their transitions a resounding success invest the time and effort to consider carefully their business goals, which vary based on whether the firm is family-owned, private equity-owned, or both. They then prepare rigorously. Virtually all leaders who say their company was “totally” prepared for their last transition report that it was a success, and almost four out of five say that it was more successful than they’d hoped. By contrast, satisfaction among companies that were less prepared is just 33%. Many negative consequences—lost sales, damaged culture, dissatisfied and defecting employees, and lower selling prices— could have potentially been avoided with better preparation.
While most middle market companies prioritize business transition planning, more than three in 10 put it down the list of business priorities, despite the likelihood that transition is bound to happen and that preparation is key. Even among companies that prioritize transition planning, the data suggest that executives are putting less time into the effort than they should. More than 40% of companies said they began planning for their last transition only in the year in which the transition occurred; the same number say they’ll wait to plan for future transitions until change is in sight. Only about a third of companies have written CEO succession plans.
Companies with private equity investment do better in all of these areas—not surprisingly, since private equity firms buy companies in expectation of selling them a few years later. Executives of these companies enjoy higher satisfaction rates as a result. But all middle market companies, regardless of ownership structure, have much to gain from a comprehensive approach to transition planning. This may include expanding the planning horizon, supplementing internal expertise with a team of advisors that can help leaders understand all facets of the transition, creating concrete succession plans, and communicating clearly with employees throughout the process. Starting this process sooner rather than later, and ideally before the transition clock starts ticking, can put middle market businesses, their owners, and their employees in the best position to reap the rewards of change while circumventing the pitfalls.