By Chris Sheppard
I recently had a good chat with an established, reputable private equity (PE) firm actively acquiring lower mid-market companies. I want to share with you what this particular buyer typically pays for the companies it acquires, the characteristics of those companies, and what kinds of deal terms the PE firm typically seeks in the transactions it conducts. Please understand that this is just one data point. Still, the information below can give you valuable insight into what PE firms are looking for when evaluating industrial or commercial product manufacturing companies.
What Does This PE Firm Pay for the Companies it Acquires?
This PE firm normally pays a multiple of Adjusted EBITDA for the companies it acquires. The typical range of value for the companies it acquires depends upon the annual Adjusted EBITDA of the company. The Adjusted EBITDA multiple varies depending on the company’s size and whether it will be a platform company or an add-on to a platform company.
Platform Companies: Adjusted EBITDA size and multiple ranges
| Size of Company (in terms of Adjusted EBITDA) | Greater than $3 million in Adjusted EBITDA.“ $3 million to $5 million is the sweet spot” for this PE firm when searching for a platform company. Will buy platform companies that have Adjusted EBITDA north of $8 million. |
| Adjusted EBITDA Multiple Range | 5x Adjusted EBITDA to 7.5x Adjusted EBITDA, maybe 8x Adjusted EBITDA if the company is best in class. |
Add On Companies: Adjusted EBITDA size and Multiple Ranges
Large Add-Ons
| Size of Company (in terms of Adjusted EBITDA) | $3 million – $4 million in Adjusted EBITDA |
| Adjusted EBITDA Multiple Range | 5x to 7.5x Adjusted EBITDA; offering prices will basically mirror platform company offering prices |
Small Add-Ons
| Adjusted EBITDA Size | $750k to $2+ million in Adjusted EBITDA |
| Multiple Range | 4x to 6x Adjusted EBITDA; possibly 6.5x for add-ons between $2 million to $3 million in Adjusted EBITDA |
What are the Company Characteristics this PE Firm Looks for in Acquisitions?
Degrees of Importance
| Important | 1 |
| More Important | 2 |
| Most Important | 3 |
| Characteristics | Minimum Desired Characteristics Low End of Adjusted EBITDA Multiple Range | Most Desirable Characteristics High End of Adjusted EBITDA Multiple Range | Degree of Importance |
| 1. Financials: Revenue Growth Rate | Some measure of growth over time | Greater than 10% | 1 |
| 2. Financials: Gross Profit Margin | Greater than 30% | 3 | |
| 3. Financials: Adjusted EBITDA Margin | Greater than 10% | Greater than 15% | 2 |
| 4. Financials: CAPEX Margin | Case by Case; Excessive maintenance CAPEX is unattractive | 1 | |
| 5. Financials: Accounting Processes, Systems, and Oversight | Can work through unorganized financials, but there must be enough there to drill down to accurate numbers | Audited financials | 2 |
| 6. Customers: Customer/Sales Channel Concentration | If the top customer represents 20% of the company’s revenue, then this is a cause for concern. DEALBREAKER: THE Company’s top customer represents 30% of revenue. EXCEPTION: If the Company is the only realistic supplier of a product or service to that large/stable customer. | 10% or less for the largest customer. If its 10% or less, then “piece of cake”. | 3 |
| 7. Customers: Types and Character of Revenue | Lumpy, project-based revenue is ok, but there should be a base layer of business that is very predictable. Some revenue volatility is fine, but must point to a long-term growth trend. | Steady, predictable reoccurring revenue. | 1 |
| 8. Customers: Sales Team | A fully developed sales team isn’t a requirement, but if the company’s sales are based on and tied to the owner’s relationships, then there must be a way for the owner to transfer those relationships. | Fully developed sales team. Company’s sales are not dependent upon owner(s) personal relationships. | 1 |
| 9. Value Prop & Competition: Value Prop Characteristics | A somewhat differentiated product/service not subject to commodity price pressures. DEALBREAKER: A commodity product/service subject to volatile pricing swings or a race to the bottom on pricing (leading to low margins). | A highly differentiated product or service with stable/growing demand and good margins. | 2 |
| 10. Value Prop & Competition: Competitive Landscape | Differentiated products; able to compete effectively without just being the cheapest option. EXCEPTION: A fragmented industry that is consolidating and ripe for rollups; but the Company must have a very good operator | Highly differentiated, excellent quality products with few competitive alternatives. | 2 |
| 11. Value Prop & Competition: Competitive Geography | Company should have at least a regional market reach. Really a case-by-case situation though.If the market radius for the Company’s products/services is less than 100 miles, this can “get tricky”. | A company that has a national or international reach into their market(s). | 1 |
| 12. Markets & Industry: Cyclicality of Industry | Demand for the product/service is as the broader economic cycle. | Demand for the product/service is less cyclical than the economic cycle | 3 |
| 13. Markets & Industry: Market Size | A mature, low growth or flat growth market can be acceptable. Industry size is important though. If the industry has flat growth, it should be in a large industry. DEALBREAKER: They don’t want flat growth in a small market – add ons don’t make sense here. | A large market that is growing faster than the broader economy. A rapidly growing market with a small to medium industry serving it. | 2 |
| 14. Suppliers: Supplier Power and Concentration | The largest supplier doesn’t account for more than 20% of the company’s COGS. EXCEPTION: where the interdependence between the supplier and the Company is profound. | Largest supplier is less than 10% of COGS. | 2 |
| 15. Personnel: Management Team Characteristics | The PE firm can work with an underdeveloped management team. | Fully developed, capable management team that is invested in staying on for several years. | 1 |
| 16. Personnel: Employees and organization | Companies with very few employees are a risk. If anyone skilled or critical to operations leaves, it can really impact the company’s performance. An example would be companies with 10 to 20 employees | A robust employee count with operational, sales, and management redundancy. This provides insurance against “brain drain” | 2 |
Typical Deal Structure and Timing
| Deal Structure Topics | Notes |
| Asset or Stock Deal? | Can do either; whatever makes the most sense each individual case |
| Percent of Purchase | Outright ownership (100% of the business). Can do a majority recap (control position; greater than 50%).Can invest in a minority stake in the business. |
| Retained ownership for the owners – Rollover Equity | The PE firm prefers the Owner(s) retain rollover equity in the acquiring entity. But the PE firm understands that there may be an elderly owner that may not be interested in rollover equity and they are flexible on this point. The PE firm considers it a good sign that the owners are willing to do a greater amount in rollover equity than a lesser amount. The minimum amount is usually 10%. The PE firm can go up to 49% rollover equity for the owners (if it’s a big enough company). The PE firm prefers to give the owners the same rights and privileges in the rollover equity as the limited partners in the fund. This is the default. The same security for the sellers as the funds LP investors. But the PE firm can be flexible to owner requests here. |
| Typical amount of leverage used by the PE firm in acquisitions | The PE firm usually uses 30% to 50% leverage on transactions. For a small add on, the PE firm might use 100% equity to purchase it. The typical percentage of leverage for the average platform company is about 40%. |
| Seller’s Notes and Earnouts | The PE firm is willing to use seller’s notes and earnouts when the PE firm believes there is a significant portion of the business’s future performance that is potentially at risk. The PE firm is willing to use contingent seller’s notes or earnouts to bridge the value gap. The PE firm does not typically use non-contingent seller’s notes. |
| Length of time from LOI to PSA (deal close) | A “comfortable” timeframe is 90 days.Can do 60 days, but not typical. A shortened timeline must account for holiday seasons. They have done a corporate divesture in 28 days once. In this case, the company had very good records and due diligence went seamlessly. |
About Chris Sheppard
Chris Sheppard is a Managing Director at ACT Capital Advisors. He has conducted/participated in over 20 transactions in manufacturing, EdTech, SaaS, business services, healthcare, oil and gas services, professional services, construction, building materials, warehousing and distribution, and transportation and logistics.
Feel free to contact Chris at csheppard@actcapitaladvisors.com or through his LinkedIn if you have any questions or inquiries.
About ACT Capital Advisors
ACT Capital Advisors is a premier mergers & acquisitions (M&A) firm representing middle-market companies across all industries. ACT has a 30-year history of deal-making, closing 250+ transactions, and unlocking over $1.5 billion in wealth for its clients. For more information, visit https://actcapitaladvisors.com/.
