Merger activity at full tilt, even before Gillette

Five weeks into the new year, the merger juggernaut is at full tilt. The biggest deals weigh in at tens of billions of dollars and unite companies that are household names: Gillette and Procter & Gamble. AT&T and SBC Communications. Travelers Life & Annuity and MetLife.

But even before January's jumbo deals rolled into the spotlight, mergers and acquisitions were on the rise among small and midsize companies. The overall number of deals climbed 8 percent to 8,313 last year, from 7,702 in 2003, while the dollar value surged 46 percent to $833 billion in 2004, from $570 billion a year earlier, according to the Association for Corporate Growth.

One new wrinkle in the merger environment is a heightened appetite of foreign buyers, who are capitalizing on the weaker dollar, for acquiring US companies.

The universe of technology businesses funded by venture capital firms is also riding the merger wave. The number of acquisitions of venture-backed companies rose 12 percent to 376 last year, from 335 the year before, while the value of those deals rocketed 75 percent to $22.6 billion in 2004, from $12.9 billion in 2003. (Dollar values include only the companies that reported sales prices for their transactions.)

While the window for initial public offerings has opened slightly in the aftermath of Google's landmark IPO last summer, there is a growing conviction that mergers and acquisitions -- ''M&As," in the vernacular of the venture capital world -- have become the ''exit" of choice for entrepreneurial start-ups.

And the megadeals unveiled last month are seen as fuel for fresh merger activity down the food chain.

''As you see these bigger deals, it's going to affect investor psychology in the middle market and the emerging market," said Dave Furneaux, managing general partner at Kodiak Venture Partners in Waltham. ''The companies that are going to be rewarded are those that demonstrate they can build brands, grow revenue, and be profitable."

Among the factors boosting mergers and acquisitions are a continuing focus on high-tech efficiencies and global expansion, and an economy that is improving, albeit slowly.

''This feels like the front end of an economic expansion," said Bruce R. Evans, managing partner at Summit Partners, a venture capital and private equity firm in Boston.

But there are other drivers: A flow of institutional money into venture capital funds early in the decade has led to an ''overfunding" phenomenon, where many technology sectors are crowded with too many similar companies backed by different venture firms. Consolidation is occurring as the strongest of these companies ''roll up" their competitors to stake their claims on an emerging market.

At the same time, the cost of going public has increased significantly with the Sarbanes-Oxley law, which overhauled accounting oversight in response to the Enron and WorldCom abuses. Sarbanes-Oxley compliance can add a minimum of $1.5 million a year to a public company's expenses, whether its annual sales are $10 million or $100 million, Evans said. Given that reality, many entrepreneurs and their financial backers are seizing on mergers as a more viable option.

Still, not everyone will make that choice.

''The allure of a public offering remains," said Evans, who noted that roughly half of the exits of Summit-backed firms over the past two decades have been IPOs. ''Some companies are concluding that it's too much of a hassle and deciding to sell. But others are willing to wait longer to go public."

The health of the merger and acquisition market is vital to venture capitalists, who depend on the financial returns from such deals to reassure the limited partners who invest in often risky technology start-ups.

''Last year's results were a positive sign that the merger and acquisition market is really making money for investors again," said Furneaux, citing the fact that the growth in the value of announced deals exceeded the growth in the number of deals.

New England has seen an increase in later-stage deals, when maturing venture-backed companies get their final funding rounds in preparation for a ''liquidity event" such as a sale or a public offering, said Matthew Littlewood, a partner at the PricewaterhouseCoopers accounting office in Boston. ''Later-state investing means you might be seeing more exits in the next year or so," Littlewood said. And that, in turn, would help venture capitalists in their next rounds of fund-raising.

''A lot of the VCs want to see attractive exits in the next year or two to show they have viable investment strategies," Littlewood said.

Robert Weisman can be reached at weisman@globe.com.