Check Mate Your competitor has just been taken over by a huge corporation. To stay ahead of the game, what should your next move be?

Like every MBA student, Dwight Schultheis was waiting for a business idea to inspire him. Then he noticed something: He and his male friends had shaving-related skin problems, and the products they used didn't help. "[We're] spending $200 on jeans, but using soap [on our faces]," he says. "It felt to me like it was a really untapped market."

Months of market research and a few focus groups later, his upscale men's grooming products company, Amenity, was born. The New York City business has grown to nine employees and annual revenue surpassing $1 million--quite a leap from last year, when Schultheis and co-founders Lisa Lehan, 28, and Kimberly Pecoraro, 32, started the company with $500,000 from personal funds and angel investors. "We're trying to be a first-mover and innovator in the men's category [of clinical grooming]," he says.

Moving could get a little trickier now that the proverbial 800-pound gorilla has entered the market. In January, Schultheis, 32, learned that Procter & Gamble was acquiring DDF, one of Amenity's competitors. The news brought a mixed bag of emotions for Schultheis, who was excited that such a big player saw potential in the $75 million U.S. market for men's premium skin care but also worried that DDF would be even more competitive with Procter & Gamble's marketing, innovation and distribution power behind it. Amenity spent the following weeks reassessing its business strategy. "If we're going to stay competitive," Schultheis says, "we're going to have to sharpen our mission."

How will you stay competitive when a big company acquires one of your competitors? It's a question you should ask, as low interest rates and favorable debt and capital markets are fueling the global M&A market, which set a record in 2006 with more than $4 trillion in deals and is on record-setting pace again this year. "There's more capital going toward M&A activity than there's ever been in the past," says J. Fentress Seagroves, a transaction services partner with PricewaterhouseCoopers' Private Company Services practice.

Many small companies are gladly making themselves acquisition targets. A January 2007 PricewaterhouseCoopers' Private Company Services survey of 286 CEOs running fast-growing private companies found that half plan to either acquire another company or sell their own company wholly or partly within the next three years. For entrepreneurs, it's "a very good time to be a seller," Seagroves says. "There are some great opportunities for smaller businesses to use this activity in the M&A market to create shareholder [value] and to enhance their own strategies."

If you don't plan to sell anytime soon, try not to panic about the entry of big players in your market. They can bring good things to your niche, like attention and new customers. But you'll have to carve out defensible ground by continuing to innovate and narrowly defining your audience, says Robert Hoffer, managing director of Newforth, an investment banking and consulting firm that has completed more than $1 billion in M&A transactions. Hoffer points to Mennen, which was able to guard against large deodorant manufacturers like Procter & Gamble by essentially becoming the big fish in a small pond. "Mennen already had the men's sports market, a narrowly defined differentiator," he says. "[Mennen had] enough size and scale in a narrowly defined niche so their media spend within that niche was large enough."

Schultheis thinks competing directly with Procter & Gamble would be a death sentence for Amenity, which instead has altered its pipeline to launch products that DDF doesn't carry and has refocused the company's distribution strategy on retail channels it thinks Procter & Gamble won't enter in the coming year. Staying a step ahead on the innovation front and expanding distribution in destination spas, boutiques, dermatologists' offices and men's grooming stores are also central to the company's new strategy. "Every new product we launch has to be right on the money because we can't afford to make any mistakes," Schultheis says.

Going after a manufacturing or distribution partnership with one of the acquiring company's competitors or a private equity firm can also help your company generate brand marketing and channel capacity to counteract the advantages the large acquirer hopes to gain in the space. Besides, the acquiring company's competitors are probably studying your market anyway. In Amenity's case, "P&G's competitors are likely to be looking in [the men's skin-care category] now," Hoffer says. Schultheis and his two business partners, meanwhile, are willing to consider an acquisition offer and have written an exit strategy for Amenity.

Finally, remember that more than 50 percent of acquisition deals fail. Says Seagroves, "Just because a competitor gets bought by a Fortune 500 company doesn't mean that's going to be a good acquisition for that competitor."

Chris Penttila is a freelance journalist in the Chapel Hill, North Carolina, area.