How Investor Clustering Affects Interest in Your Deal

Great news — a client you’re advising is going to earn $1.1M in EBITDA this year, up from $900K last year. Although this growth seems relatively small and the overall business structure is unaltered, interest in the deal suddenly increased. More buyers are asking how the business would integrate with theirs, how the different product lines look, and when they can meet the management.

The owner is confused. Where did these buyers come from? The business really didn’t change much. Were you not working hard enough before?

As it turns out, investors have a tendency to cluster around arbitrary financial thresholds and M&A is no exception. Actually, in many ways the thresholds for the middle market are even more acutely defined. Crossing over one of those thresholds can completely change the interest of an investor, even if the business hasn’t changed in other ways.

To get a better understanding of how this dynamic works, we took a deep dive into the data on Axial before interviewing Members Frank Gallucci, Managing Director at Whitestone Associates, and Mark Turgyan, Director of Corporate Development at Conair.

On Axial, investors express their investment interests by creating Transaction Profiles that detail the criteria they use for investments. By aggregating the data from all of the Transaction Profiles currently on our network, we discovered two interesting trends:

First, when investors consider EBITDA as part of their criteria, most tended to cluster around thresholds of $500K, $1M, $2M, $3M and $5M. As the graph demonstrates, if the earnings of a company pass the $1M threshold, the potential buyer pool has expanded by nearly 41%. Passing $2M gets you nearly an additional 14% growth in potential buyers.

Second, not everyone considers EBITDA — nearly 46% of investors don’t use EBITDA as a criteria in evaluating a deal. They focus instead on other criteria like geographic location, industry and customer types to make investments. As Mark Turgyan echoes below, it’s much more about fit than numbers.

Distribution of Investors with EBITDA Minimums

According to Frank Gallucci, “If we can show either past history or a reasonable run rate in the current year of $1 million EBITDA, our phone calls are returned immediately, and we have very constructive conversations.” In many cases, even if companies are just shy of that $1M EBITDA marker, “it seems that our calls are returned out of professional courtesy – not actual interest.” Gallucci added, “Below $1 million, many private equity firms seem to wonder whether the company is truly a business and, unless they specialize in very early-stage investments, they tend to pass.”

The threshold is even more rigid for larger companies, Gallucci explained. “If you’re a billion-dollar company, it may not pay to acquire a company that isn’t going to impact earnings per share or materially impact potential sales in the near future. You simply don’t have the resources to look at every potential deal, so you end up focusing on companies that will make a difference for the company, and that requires an acquisition to have some minimum size requirements or extremely useful technology.”

Mark Turgyan of Conair explained that some of their quantitative thresholds vary based on the qualitative aspects of a business. For example, from Conair’s perspective, “If we’re looking at stand-alone companies, we’re looking at something in the $30-40M revenue range at the low end.”

The acquisition thresholds change when a strong brand is involved. In these cases, “We don’t really have a low end. We’ve purchased smaller companies for their distribution and brands. We’ve looked at deals as small as $2-3M revenue and selling to 2 or 3 customers where the seller had a nice established brand. Since we already had relationships with their clients, we took over their product range and integrated it into our existing business.”

So where do you go from here? These thresholds may seem like insurmountable obstacles if you fall on the wrong side of them, but this is not necessarily the case.

The most important step you can take to overcome these thresholds is to find the buyers who don’t abide by them. Just because certain buyers have a $1M EBITDA minimum does not mean all do. It is essential to use tools like Axial to discover these long-tail buyers with more specific and appropriate interest for deals of certain sizes. For example, we recently learned that one of our Members received an LOI on a health care company they are representing that generates just $270K in EBITDA. With nearly 25% of our Members having minimum EBITDA thresholds under $1M and 46% having no minimums, these types of interactions are relatively common.

Another step to lessen the strictness of these threshold barriers is to acknowledge them with prospective buyers. Find out why a buyer has certain minimum (or maximum) parameters. If the parameters are truly arbitrary, you may be able to stretch a buyer’s threshold and therefore their interest in your deal.

Lastly, it is important for you to prepare and inform your clients about these apparent barriers. By ensuring that they understand where these thresholds lay and why they exist, you can help the client develop realistic expectations. Feel free to pass this article along to them so they can see the data (and other deal professionals) corroborate the segmented reality of the deal market.