10 Biggest Mistakes When Buying a Platform Company
One of the most interesting developments in the private company M&A market that we at The MBO Group have seen over the past few years is the emersion of a new buying group seeking to acquire private companies.
This group consists of:
- Serial Entrepreneurs - individuals who have grown their businesses to a certain level, cashed out and want to get back in by buying / investing in a smaller company;
- C –Suiters – executives from large corporations who either became fed up with large corporate life or have been downsized and who are now seeking to acquire a small company to grow; and,
- Pools of High Net Worth capital who are looking at ways of investing in private companies.
These buyers are often looking to acquire “platform” companies. A platform company is a company in a sector that an outsider acquires and uses to make acquisitions within the sector, acting as an industry consolidator for retiring baby boomer entrepreneurs in that sector.
All these buyers have one thing in common – they know that one of the best ways of getting a superb return on their investment is to buy small private companies, grow them to the next level (or beyond) and then sell them.
- Valuations are lower for smaller companies than larger ones;
- By acquiring a “platform” company and successfully executing an acquisition strategy, you drive both the EBITDAs and the Valuation Multiples, resulting in spectacular returns on your initial investment; and,
- Most entrepreneurial companies stall at a certain sales level. Many entrepreneurs don’t have the “corporate” skill set needed to bring their companies to the next level – and these are the skill sets that the “platform” buyers bring to the table.
But these buyers also have some unique challenges when seeking out their perfect “platform” company including:
- Having a flawed search strategy
Too many people who are looking to buy a private company don’t employ a proper search strategy. A proper search strategy is a full time and disciplined process – and the more prepared you are the more likely you will succeed.
A proper search strategy includes:
- Having a clearly defined target profile Going into the market and telling people that you’re look to acquire a “good little company” seldom gets you any results. We encourage individuals to put their target’s profile on one page and the more specific the better. These “specs” should include an industry description, a specific revenue range, acceptable geographic boundaries and any unique qualities that you consider critical (such as % of sales supported by long term contracts, % of service revenue). These detailed specifics are invaluable when cold calling potential targets and intermediaries.
- Looking at the search process as a full time job You’re looking for a diamond in the ruff, so you’ll have to do some digging. Your likely platform company is probably not officially for sale, but could be. As such, you’ll need to reach out to hundreds of targets. In one of our searches (looking for a local commercial HVAC business) we approached over 500 companies and discovered that 111 of them roughly fit our criteria. This process is very time consuming and only a methodical and disciplined approach will help you uncover your “diamond”.
- Create a public personal profile One of the biggest challenges in approaching target companies “cold” is getting past the gatekeeper (i.e. the receptionist) and getting the owner to take your call, and then open up to you. Make it easy for them to quickly understand that you’re a serious buyer who is worth listening to and is someone who can be trusted. If you are not working with a professional advisory firm (which lends instant credibility to you and your search) then the best way to establish your credibility is to have a personal website. Your website doesn’t have to be a work of art – it simply has to very clearly explain who you are and discuss your search goals and vision.
- Trying to rush a deal
It’s human nature to want to get a deal done quickly and dive into your new venture. But as this will likely be one of your biggest financial investments, you’ll need to take your time, both in finding the right company and in the subsequent negotiations with the target company.
Some of the best deals are the ones that take the longest to do. Why? Because most sellers want 100% cash at closing while you want to get them to provide some vendor financing. Spending time with them – creating a trusting bond, getting them to buy into your vision, and demonstrating that they could possibly make more money if they “stay in for bit” – can often result in a “win – win” deal for you and the target’s owner.
- Getting Deal Fever – not listening to your due diligence
Deal fever happens when you’ve got so much time, energy and emotion tied up in a deal that your focus shifts from doing the right deal, to simply getting a deal done. Even seasoned private equity pros get deal fever – it’s hard not to.
We’ve seen too many deals where the buyer has ignored the negatives findings that came out from the acquisition due diligence process and lived to regret it.
One of the best pieces of advice on this point came from a seasoned private equity investor who told us “Some of the best investment decisions I’ve ever made were ones where I walked away from the deal”.
- Paying too much cash upfront & taking on too much bank debt
Buyers do this because they either (1) succumb to Deal Fever, or (2) get too aggressive in their views on future performance.
Things always take longer than you think. And you are never 100% sure of the reaction that your new customers will have to the acquisition.
While the seller will pressure for more cash up front, you need to structure a deal that ensures that you get what you are paying for. And in private company acquisitions, this normally requires payments to the seller that are tied into certain future performance – sales levels, EBITDA levels, key suppler support. So you’ll often see that a large amount of the deal's “purchase price” is in the form of delayed payments to the seller that are often tied into future performance of the acquired company.
And be careful about taking on too much bank debt; if you experience any hiccups with your newly acquired company you don’t want to be dealing with a nervous bank manager at the same time.
- Getting greedy – the wrong mix of financing
There are various sources of financing that may be available to complete your deal – banks, term lenders, subordinated debt providers, private equity, vendor financing – all of which have different costs and attributes. Banks are your cheapest form of financing but they have strict rules that you need to live with while private equity is very expensive but also very patient.
You may well be tempted to go for the cheapest financing and / or the one that allows you to keep the most equity. This may not be the best approach. Why? Because the financing that you get to buy your company also has to be capable of allowing you to grow the company and weather the bumps along the road that you will inevitably experience.
Once you’ve run some financial “what if” scenarios, you may decide that, for your long term success, you would be better off having a smaller slice of a much more successful and stable “pie”. This means financing your acquisition with more equity type money and less bank debt.
- Not understanding your financial partners
Each of the sources of financing noted above has their unique rules of engagement and it’s very important that you understand these rules.
Banks are not your equity partners and, if you attract a private equity investor, you’ll soon discover that private equity partners are very different from you banker.
Obviously you need to treat all your financial partners with openness, honesty and full disclosure. But one of the keys to successfully growing your business is to understand what each of your financial partners will and won’t do.
- Under appreciating the importance of key people
Most “platform” seekers are looking for relatively small companies to acquire and build upon. As such, your target company is likely quite lean and has relied heavily on the owner, or one or two key people.
Platform buyers often come out of large corporations and may not have had a great deal of exposure to smaller entrepreneurial enterprises. And Wall Street is a very different world from Main Street.
So spending the time to really understand who the key people are in your target company is time well spent. If that key person is the owner, then you’ll need to structure your deal so that the owner is paid a significant portion of the “purchase price” over time as they successfully transition the business to you.
If that key person is a manager, then failure to win over that manager going forward could slow or jepordize your growth plans. One way to secure their loyalty is by bringing them in as “partners” – either with a small equity piece, phantom shares or an ESOP (Employee Share Ownership Plan).
- Not understanding the hidden costs of a deal
When acquiring a company with a limited amount of equity, every cent counts. First time buyers are often shocked at the unexpected expenses that accompany their first acquisition, including:
Transaction related costs such as:
- Due diligence costs including obtaining outside advise on environmental, accounting and tax issues required by both you and your financial partners
- Transaction advisory and legal fees
- Lenders’ / investors’ fees
Legal fees are probably the area that give most first time buyers the biggest shock. It’s not uncommon to see legal fees escalate significantly beyond the initial budget as issues arise as you complete your due diligence.
Post transaction related costs that are often underestimated include:
- Upgrading the accounting / IT area – almost always required
- Layoffs & new hires in the first year – inevitable as you instill a new culture
- CAPEX upgrades
- Not having a growth strategy
While every buyer has a different motivation for acquiring a company, a good rule of thumb is to only acquire a company that you believe can double its EBITDA within 5 years. This growth should allow you to comfortably pay off your debt and significantly drive the value of your company.
But this growth doesn’t just happen – it comes from organic growth and / or through acquisitions. Rarely can you drive significant sustainable EBITDA growth through cost cutting or reengineering the business alone.
So while the sometimes exhausting process of finding and acquiring your “platform” company may have you considering targets outside of your initial comfort zone, before you take the jump, and before you lock up your financing, step back and re-evaluate your growth strategy and make sure that you can realistically attain this five year goal.
- Going after the next deal too quickly
This is the next phase of “Deal Fever”. You’ve done your first deal (and enjoyed the “rush” of the deal) and are starting to see your vision realized. You and your financial partners are all excited about the future and now you want more!!
This may not be as easy as it first looks. Make sure that you’ve nailed down this first acquisition before embarking on the next – take your time and get it right. Ensure that your “platform” company is ready to embark on an acquisition strategy and that the underpinnings are in place to allow for this growth. There are lots of potential acquisitions out there that are not going away. A disciplined, patient and methodical acquisition strategy is your ticket to success.
In Their Words
The MBO Group seems to have a unique ability to uncover interesting and worthwhile opportunities in the Canadian private company market. I have had the benefit of working with them in a variety of situations. They have always been able to capture the essence of what makes a project assignment or deal work in a very strategic way that others can embrace. With a rare ability to communicate clarity they are able to efficiently bring individuals as well as groups to understand what it takes to achieve success.
FCA, Former CEO & President, Marsulex Inc.