The urge to merge: more small to mid-sized companies consider M&A as a growth strategy.

In a June 2003 Trendsetter Barometer survey of more than 400 CEOs of high-growth firms, PricewaterhouseCoopers revealed that of the CEOs who planned to implement special initiatives to generate new business growth, 20% planned to use mergers and acquisitions to get there.

While most small companies tend to grow "organically" by slowly adding clients, business lines, employees, and physical space, others prefer to bulk by merging with or acquiring another firm, or by being acquired. "Small businesses have traditionally been acquired on a large scale, but the pace at which these firms acquire one or more companies has picked up over the last few years," says Louis L. Iorio, president and founder of Corporate Investment International in Short Hills, New Jersey.

Iorio's firm is a merger and acquisition matchmaker for companies with market values of $300,000 to $15 million. One of them is an aerial mapping firm that was on the prowl two years ago for a merger partner in a similar or complementary industry. Iorio targeted the civil engineering field as a good candidate because such firms need aerial mapping capabilities, but don't always have the facilities in-house.

"The merger gave the engineering firm that ability and also opened up new markets to each partner," says Iorio. "The engineering firm could expand into the aerial mapping environment, while the other company was able to move into the engineer's environment. It worked very well for both sides."

Mergers and acquisitions among business entities typically take one of two forms: an acquisition, in which a small business folds a new company into its existing operations (of vice versa, if the small company is being acquired); or a merger, where both companies are typically dissolved and a new entity is created.

Why would a small business want to do this? For several reasons, says Iorio. For starters, a smaller firm might want to expand its niche or geographical reach, but may not have the internal resources to achieve that goal. By purchasing a competitor already operating in those desired markets, for example, a small business owner can extend its reach without adding employees and locations. And because small businesses tend to rely on a few key customer accounts, Iorio says that acquiring another firm also provides a good diversification channel. The acquisition of a company that offers complementary services or products can expand the resultant company's product and service portfolio exponentially.

Doubling your business and sales channels requires intensive due diligence. "Small businesses are typically driven by one or two players who aren't always frank about their strengths and weaknesses," says Ken Epstein, principal at NewCap Partners Inc., a Los Angeles private investment banking firm that facilitates mergers and acquisitions for small private companies.

"When you have two small companies coming together or one acquiring another," Epstein adds, "the fact that they're not [always] honest about financials, operational capabilities, and weaknesses can undermine the deal." Iorio agrees, and says all companies should "truly understand their own business environment," before buying or selling.

Before you merge, acquire, or sell ...

Get our own financial house in order

* Be honest and upfront about your firm's weaknesses, then find a partner who can help "fill in time gaps."

* Do extensive due diligence on the company you're selling to, merging with, or acquiring.

* Find a complementary partner or business. Consider, for example, potential M&A targets that operate outside of your main line of business.

* Pay close attention to the growth potential of the newly formed entity and don't let it get out of hand without first creating a strong infrastructure to support it.

* Look at the newly formed relationship as a marriage, not just a business partnership.

* Learn the ropes. You can start by reading The Art of M&A: A Merger Acquisition Buyout Guide (McGraw-Hill Trade; $125) or Due Diligence for Global Deal Making: The Definitive Guide to Cross-Border Mergers and Acquisitions, Joint Ventures, Financings, and Strategic Alliances (Bloomberg Pr; $75).