Strategic Drivers of M&A in the Middle Market, Part I: Increasing Business Development Burden
An increasing portion of Federal contractor M&A activity in recent years has been characterized by the emerging phenomenon of transactions amongst middle market companies. This trend has been driven primarily by: (i) ability to enhance business development capabilities; (ii) increasing middle market competition; (iii) the challenge of transition from small business to large, and (iv) capitalizing on priority market access. This represents the first in a series of blogs that will explore each of these drivers and the market reactions they have required in more detail.
Due to budget uncertainty at the procurement office level, Federal contractors are currently experiencing lengthening procurement cycles coupled with shortening contract terms. In conjunction, these factors result in more frequent recompetes and compel significantly more financial and human resources to be dedicated to Bid and Proposal (“B&P”) activities. The combination of these two factors has amplified the financial and human capital burden on smaller contractors, as they are induced to allocate relatively more resources towards business development to ensure revenue continuity at minimum or grow.
While larger Federal contractors have designated business development groups and are better able to absorb increasing costs, smaller companies are asymmetrically affected. With relatively lower access to business development resources, smaller contractors many times resort to pulling in direct-billable employees or hiring expensive external consultants to assist in procurement activity. Nonetheless, the middle market as a whole continues to look for ways to stay competitive from a business development standpoint.
The increased business development burden on small- and mid-sized companies has been a driver for a wave of middle market consolidation in Federal M&A. Several relevant transactions of the past 24 months have highlighted this investment thesis. For example, for Dovel and RNSolutions the combined business development engine in terms of resources, expertise and access were greater than the parts. In situations like these, consolidation of business development functions across entities results in scale economies that generate higher margins and cash flows, creating additional incentives for small- and middle-market firms to pursue M&A strategies. As budget and procurement cycle uncertainties persist, we can expect additional middle market consolidation as contractors use M&A to create organizational efficiencies.