By Tim Fisher
While entrepreneurs are often heralded for taking well-calculated risks that allow them to build successful businesses, we have also seen founders relentless focus on team building as one of the biggest drivers of success. They know from experience that one must assemble, manage and motivate top talent in order to reach full potential. As a result, entrepreneurs often grasp the value-add of partnering, or “teaming up,” with private equity. In some cases this also allows management to create a second bite at the apple, which can often be more valuable than the first bite.
Recently our firm advised a middle market company with about $60mm in annual revenue and zero debt. Management wanted to sell the entire company to a strategic acquirer for 6x-8x EBITDA. However, with 45 percent of revenue coming from one customer, we were worried that prospective acquirers would use customer concentration risk as a tactic to limit the exit multiple.
Despite the inherent risk of substantial customer concentration, the firm has relatively strong free cash flow and a pristine balance sheet. During our due diligence, we realized the company’s industry is highly fragmented with no dominate competitor. In fact, the largest competitors in the space are a few multi-billion dollar public companies with less than 5 percent market share individually.
We suggested that the firm position itself to serve as a consolidation leader and then consider a partial sale to a middle market private equity firm with a track record of successfully executing industry roll ups. In effect, mitigating a negative attribute acquirers would use to push back on valuation multiples (i.e., customer concentration) and creating a bigger company on which to apply this higher valuation multiple.
If we could help these smart, successful, charismatic entrepreneurs make one accretive tuck-in acquisition and get letters of intent from several other small competitors, then they could sell a majority stake in this consolidated entity for an attractive valuation multiple to a private equity firm and still retain a 30 – 45 percent equity interest in the new entity. Through accretive tuck-in acquisitions the company could effectively diversify itself away from its customer concentration exposure and position itself to realize economies of scale, ultimately becoming an industry leader with higher organic growth prospects than a smaller competitor in a fragmented market sector.
In the end, the entrepreneurs will have a second bite at the apple which is hopefully bigger than, not only the first bite, but also the entire original apple for which the founders were initially willing to settle.
Sometimes the easiest option is not always the optimal option. It would have been easy to sell the company in an auction process to the highest bidder. Yet, if we can collectively figure out creative ways to team up with companies to either eliminate or reduce problems and identify accretive growth solutions, then we will truly create value for our clients and the management teams with whom we partner.
Tim Fisher is a principal and co-founding member at Cerminaro Group. The firm provides executive management advisory services in the areas of strategic growth initiatives, capital formation and new business development. In addition, the Cerminaro Group manages a proprietary pool of capital, which, it invests in the debt, and equity of select client mandates either as a majority or minority equity investor.