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Competing in a Hot Market and Exciting Deal Pursuits
Drew Eckman
May 31, 2024
Greetings everyone,
I’ve dialed back the frequency of my posts so I focus on buying a business rather than writing about it. 😄
Here’s what you can expect from this update:
Updated deal stats for March through May, plus my aggregate deal funnel.
How I’m thinking about competing for and selecting deals in a very competitive market.
Two deals I’m currently pursuing.
Let’s dive in.
Competing to Win Deals
The current market for small businesses is extremely competitive. The demand from buyers far exceeds the supply of good businesses, and I’m seeing people overpay for bad deals.
Sub-scale deals in construction-related, cyclical industries are selling for 4x SDE, often ignoring real post-closing costs (like maintenance capex for vehicles). Buyers are leaving themselves with very thin margins for error.
I hate to use the word “bubble,” but it feels a lot like a bubble right now.
When competing for deals, I categorize my competition into two main groups: (1) financial buyers using SBA financing, and (2) strategic buyers or private equity funds (including PE platform companies looking for add-on acquisitions). Here are my thoughts on competing against both.
Competing Against PE / Strategics
First, some caveats: I plan to use SBA financing, source deals through intermediaries (brokers and M&A advisors), and limit my focus to larger, more competitive metros.
Given these constraints, if you want to buy a sizable business ($1M+ EBITDA) targeted by private equity and strategic buyers, your best strategies are to:
Option A: buy a business with one or more red flags that caused others to “pass” on the opportunity, OR
Option B: Use a creative structure to get “close enough” on price, while positioning yourself as the preferred buyer due to aligning with the seller’s goals (e.g., preserving the legacy of the business).
While Option B is often promoted as the edge that acquisition entrepreneurs have, I find that there are far more opportunities under Option A. Competing with PE/Strategics on $1M+ EBITDA deals is challenging if you’re an SBA-buyer because getting close on price is tough. But no matter how creative you get on structure, using SBA makes a 6x+ EBITDA multiple untenable (unless you give up control of the company).
For more insights on how acquisition entrepreneurs are competing with PE firms, check out this article by the CEO of Axial:
To compete with PE / Strategics, I’m focusing on the possibilities of:
Identifying desirable industries not yet consolidated by PE.
Buying smaller, sub-scale businesses.
Finding companies with serious red flags and devising strategies (through deal structure, my unique set of skills, and vision for that specific company) that helps mitigate those risks effectively.
All easier said than done.
Competing Against Other Financial Buyers
If you target industries not heavily pursued by PE/Strategics or go for smaller deals, your competition will likely be other SBA buyers.
This raises the question: What industries and red flags am I willing to consider to get a deal done?
Rather than speak theoretically, I thought it would be interesting to provide an example of a business that I recently bid on: a windows and doors contractor. I think it’s interesting because it has many characteristics that business buyers would normally avoid.
Windows & Doors - Industry Analysis
Below is a chart that breaks down the hallmark characteristics that are used by many acquisition entrepreneurs to evaluate companies and industries, including where windows and door contractors fall on each category.
Category | Most Desirable | Undesirable | Windows + Doors Contractor |
|---|---|---|---|
Fragmented industry | Fragmented | Highly Consolidated | Fragmented |
Industry Growth | Growing | Declining | Modest Growth |
Revenue Model | Recurring revenue | Project-based revenue | Project-based |
Size of industry | Huge market / Huge # companies | Small market / Low # companies | $300M+ / 32,000 companies |
Operational Complexity | Straightforward operations | High technical complexity | Straightforward operations |
Healthy & Sustainable Margins | Healthy EBITDA margins (20%+) | Lower margins (<15%) | Low margins |
High Barriers to Entry | High barriers / limited competition | Low barriers / high competition | High competition |
Cyclicality | Recession resilient | Cyclical | Cyclical |
Necessity of Services | Necessary | Discretionary | Discretionary |
So, you might ask "what the hell is there to like about windows and doors contractors?”
This is a consumer-facing, lower-margin, project-based revenue business in a cyclical industry with high average ticket prices ($20,000+) for a discretionary purchase (a “want to have” service, not a “need to have” service). But I found some desirable characteristics.
Desirable characteristic | Notes |
|---|---|
Regulatory Tailwinds | As the government continues to push for energy efficiency, theres' greater likelihood of government incentives in windows / doors / glass. |
Aging Housing Stock | The US has an increasingly aging housing stock. More than 90% of U.S. homeowners with mortgages are locked in at rates below 6%. ~83% are below 5% rates. Those point to a growing remodeling market. |
Weather-related events | More weather-related events creates demand for impact products. |
Lack of sophisticated operators | Unlike HVAC & other home service businesses that have been flooded with sophisticated PE-backed operators, windows and doors has yet to see significant investment. |
Fragmentation / Growth Opportunities | Fragmented industry with large number of local operators make growth via M&A roll-up a viable strategy. |
Entry price | Avg. multiple across 21 deals I reviewed from the last 5 years showed ~2.60x avg. EBITDA multiple. |
The last point (entry price) is crucial. In a major recession, demand might plummet, but paying ~2.6x earnings and using minimal Senior bank debt on a well-established business can mitigate a lot of risks.
I met with the owner, learned more about the business, and made an offer. Unfortunately, the “listed” earnings were inflated. They didn’t account for post-close operator salary, maintenance capex for an aged vehicle fleet, and included questionable “addbacks” to earnings.
Another SBA buyer submitted an LOI at full asking price, which I estimate to be ~4.5x the true cash flow of the business.
And this is why competing against other SBA buyers is so challenging at the moment. The deal might technically meet SBA requirements, but it does not make financial sense at that price.
Takeaway: if my primary competition on a deal is other SBA buyers, I’m expecting to push towards 4x EBITDA. I need to really like the industry and the business. Unfortunately, I’m seeing bad deals going under LOI at 4-5x EBITDA.
Two Deals I’m Pursuing Currently
There are two deals I’m currently pursuing that are at different stages: (1) a luxury real estate marketing agency, and (2) a residential roofing business.
If anyone in my network is knowledgeable on either of these industries (marketing agencies or residential roofing), PLEASE email me. I’d love to connect!
I’ve put in an offer and met with the owner of one business. I’m waiting on a counter-proposal and will promptly submit an LOI with a good chance of being accepted.
For the other opportunity, I plan to make an offer once I get more detailed financials. It’s a large business, so I’ll get early feedback to see if I’m in the ballpark with other prospective buyers before investing too much time.
Conclusion
Thank you for following my journey. The market is challenging, but I’m committed to finding the right opportunity. Stay tuned for more updates, and feel free to reach out if you have insights or connections in the industries I’m exploring.
-Drew