When Little Companies Bulk Up

By GEORGE J. CHURCH

The merger deal had been under discussion for two months. Finally, all the intricacies had been worked out. The last step in sealing the agreement turned out to be...a moonlight disco-dancing cruise?

If the word merger conjures up only thoughts of deals to join corporate giants like Exxon and Mobil, conjure again. What headline writers call "merger madness" is also breaking out among relatively pint-size companies, which seal new relationships in the cafeteria and celebrate with interpersonal mingling that can involve the whole staff. These not-so-big deals sometimes seem to occur in a business world altogether different from the one inhabited by the megabillion-bucks monsters. Witness the just completed merger of Personify and Anubis, two California e-commerce companies.

BYTING AND SWALLOWING

Like many new high-tech firms, both were growing fast--but not fast enough to keep up with the demands of their customers. Personify, founded in San Francisco in 1996, builds software that lets an e-marketer keep track of visitors to its website, what pages they look at, and how long they take to pick out something or go elsewhere. By last summer it had signed up 50 clients that were paying Personify about $6.2 million--and demanding more and different kinds of services than the company's 60 employees could supply. CEO Eileen Gittins decided the best way to get additional talented and experienced workers fast was to buy another company--a motivation driving many other little mergers, even in labor markets not quite as supertight as Silicon Valley's.

Gittins spotted Anubis Solutions, an Alameda company that helps businesses manage and interpret electronic data on their customers. It had tripled revenues in each year of its 3 1/2 years of existence. "But there were some huge opportunities" to expand even more rapidly, says co-founder Adeeb Shana'a, "and if we didn't move fast enough, we would lose the potential." Shana'a and co-founder Amit Desai had been determined to shun outside investment, but now they were ready to consider it, and they put out feelers to a venture-capital firm. The financiers offered an introduction to one of their client companies. That turned out to be Personify--somewhat to the shock of Anubis, which had been studying Personify as a potential chief rival. Shana'a and Desai quickly concluded that the companies were an even better fit as partners.

Then began what both sides describe as more of a "dating process" than a financial negotiation. Blending two corporate cultures can be a problem in big mergers, but it is far more crucial in small companies. If their employees do not get along with one another and leave for a more congenial atmosphere, the merged company can easily be wrecked.

Personify and Anubis took no chances. First, Gittins and Personify president Steve Krause got together with Desai and Shana'a over a weekend to chat, not about finances but about "What's important to you guys? What gets you out of bed?," as Gittins puts it. Next, the Personify pair spent a day at Anubis headquarters and lunched with employees in the cafeteria. Gittins recalls telling Krause, "That felt just like us. The space looked like us, the people looked like us, the microwave smelled like popcorn just like ours." As a deal got closer, "cultural ambassadors" shepherded groups of lower-ranking employees on similar visits to the opposite firm's quarters. Finally, the companies took everybody on a boat trip on San Francisco Bay. "It was a beautiful night," says Gittins. "We got everybody out on the dance floor with disco music and got to know one another on a social level. After that, we were really 'we.'"

HOW SMALL IS SMALL?

That courtship may have been more elaborate than most, but the eventual combination was anything but unusual. Small mergers have been increasing rapidly enough to become an important force in the economy. Mergerstat, a division of the national investment bank Houlihan Lokey Howard & Zukin, defines a "small" merger as involving $50 million or less. In 1992 it tabulated 639 such deals totaling $9.5 billion. Last year there were 1,502 combinations worth $25.4 billion. Projected totals for 1999: 1,935 deals, $35.9 billion. The DAK Group, a New Jersey-based investment bank, early this year conducted a joint study with Rutgers University querying bosses of 159 small businesses; 36% of them planned to buy another firm during the next 12 months.

One reason for the surge is that after nearly nine years of economic expansion, there is a lot of money floating around. "The time is right, and the pricing is high," says DAK president Alan Scharfstein. Entrepreneurs "are able to get value for their companies that they don't know if they can replicate" in the future. And buyers sometimes can raise astonishing sums to finance an acquisition. Case in point: Good Earth Organics, a producer of lawn and garden supplies based in Lancaster, N.Y. Until two years ago, it had only 25 employees, seven of them members of the founding Burkhardt family. But then it managed to borrow $25 million and acquired Pioneer Southern, a company roughly 10 times its size (250 employees). Says vice president Monika Burkhardt: "We became known as the small fish that swallowed a whale."

What drives these little mergers is not only the grow-fast-or-stagnate conviction that pushed Personify and Anubis. In the high-tech field especially, that motivation has coincided with a drastic change in the psychology of entrepreneurs. Many no longer expect to found a company, run it for 30 or 40 years and then turn it over to their heirs. Instead, some leaders of the post-Gates generation plan to build a company for perhaps 10 years, sell or merge it into a bigger entity and go on to something else.

John Groves, 36, exemplifies both trends. He founded Open Microsystems, an Austin, Texas, electronic-software-and-services company, in 1991. Seven years later, he had built it into a $5 million business. But, he says, "we had to raise a lot more money or settle into a growth rate that in my opinion wasn't enough for long-range prosperity." So in 1998 he sold out to Gresham Computing, a British firm. Gresham coveted Open Microsystems' technology, employee team and customer list. In return, Gresham enabled Open, now renamed Gresham Enterprise Storage, to "get into deeper pockets," as Groves puts it.

THE GOAL: OUTWARD MOBILITY

At the time of the merger, the combined revenues of Gresham and Open Microsystems totaled roughly $30 million. In only a year and a half, that has grown to $50 million. For Groves, though, the merger was a success in another sense--as "a way to build a bridge that would eventually get me out of there. My m.o. is to build something quickly" and then move on. He has no intention of emulating Oracle founder and still chief Larry Ellison. Oracle, Groves remarks, "got really big, and that's terrible because you can never escape from it."

To many other small-business owners, talk about building a new Oracle, pro or con, sounds roughly as relevant as chatter about a space cruise to Pluto. They consider mergers and acquisitions the only way not just to grow but sometimes even to stay afloat.

"With a small-business guy, it's a day-to-day struggle to survive," says Larry Mocha. He is president and owner of Air Power Systems Co., a Tulsa, Okla., maker of air cylinders and other parts for trucks that his father founded in 1964. At times, Mocha recalls, he had to borrow on his personal credit card to meet his payroll. A year ago, though, he bought the assets of a local machine shop whose owner was "tired of being a small businessman." The acquisition enabled Air Power to double its production capacity. Now Mocha is looking at two more potential acquisitions, each of which would cost around $100,000 to $150,000; they may be a way to increase sales and profits without adding to his 24-employee payroll. But Mocha has no dreams of becoming a conglomerateur. "I know the truck-equipment industry," he says. "But if I were to buy a waffle shop, the learning curve would be very high for me."

Mocha's comments point to another difference between little mergers and the monster variety (besides the obvious one of size). Although the conglomerate craze is waning, most big-time mergers still aim at a degree of diversification. But small firms almost always combine with others in the same industry. That, of course, frequently means mergers of direct competitors or potential competitors, like Personify and Anubis. But while trustbusters may try to stop such a merger between two giant competitors or at least attach onerous conditions, they are almost sure to ignore combinations of little competitors. It is difficult to imagine a combination the size of Personify-Anubis or Gresham-Open resulting in a significant reduction of overall competition.

Another difference: giant mergers often aim at reducing costs by consolidating operations, and this almost invariably involves large layoffs. But the non-titans usually want to expand where they overlap. As with Personify and Anubis, "a lot of times a company will buy another company just because it means acquiring good employees," says Jason McCabe Calcanis, editor and CEO of the Silicon Alley Reporter, a magazine that tracks digital media.

PATERNALISM ON THE PROWL

"There are almost no short-term cost savings [in a merger] if you do it right," says Fred Zimmerman. He has been on 16 company boards as a small businessman turned professor (of engineering and international management) at the University of St. Thomas in Minnesota. He counsels would-be acquirers to be prepared for an increase in expenditures beyond the price of the acquisition. Says Zimmerman: "You'll want to improve the [acquired] company because it's now your property. So you'll probably want to buy more equipment or expand distribution or develop a new product. These are all expensive things."

All of which can make small-company combinations harder to arrange than big buyouts. John Mavredakis, senior manager of the Houlihan Lokey investment bank, has helped arrange both types. "When we work with large corporations, everything is methodical and rational," he says. "With smaller companies, emotions come much more into play. Personalities play a major role. There is the need of the entrepreneur, his desire to make sure that his employees are being treated fairly and that he is giving them a good home."

Sandy Batkin, 76, is one such paternalist. He felt he had to sell his Universal Folding Box Co. in Hoboken, N.J., after his heirs made it clear they had no interest in carrying on the business. But he held out until he found a buyer, Workflow Management of Palm Beach, Fla., that would pledge to keep his 165 employees. "I know almost all the employees by name," says Batkin. "I know their families. It was very important to me that I sell to a company that was not going to liquidate and move the business somewhere else."

Such attitudes help deflect the hostility that big mergers often arouse. Rightly or wrongly, many communities fear that big mergers equal big layoffs and a loss of control over the local economy to faraway conglomerateurs. Since little mergers usually aim at faster growth and, eventually, more employment, they are usually seen as a positive force in the economy--and that perception seems correct.

--Reported by William Dowell/New York, Marc Hequet/St. Paul, Hilary Hylton/Austin and Susan Kuchinskas/San Francisco

With reporting by William Dowell/New York, Marc Hequet/St. Paul, Hilary Hylton/Austin and Susan Kuchinskas/San Francisco