What Do Buyers Look for in the Lower Middle Market?

For owners looking to sell their businesses, it can be hard to know what buyers find attractive. This is particularly true in the lower middle market.

In my work in the exit planning industry, I’ve seen countless owners struggle to pin down what will make their business valuable to potential acquirers.

I asked two experienced investment bankers for their thoughts. Tom Majcher of Majcher Group, LLC focuses on sell-side representation in the $5 million to $25 million range — i.e., the lower end of the lower middle market. Kevin Short of Clayton Capital Partners works with businesses with $2 million to $10 million of EBITDA, most with value exceeding $25 million.

Who are the buyers in this market?

Tom: In this lower range of business value, there are a lot of financial buyers, private money, and search fund advisors. The latter are (often young) entrepreneurs with limited experience but adequate financial backing from investors. There are few strategic buyers for companies in this value range.

Kevin: Strategic buyers are usually not interested in companies in Tom’s market because they want to acquire companies that “move the needle” for them. Depending on the characteristics of an owner’s business, strategic buyers, financial buyers and private equity firms will all be potential buyers.

What are buyers looking for?

Tom: To owners who want sell their companies to third parties, I review with them the attributes of camera- or transaction-ready companies that buyers expect. These attributes include:

• A strong management team (apart from the owner) that is properly incented and is prevented, via employment agreements, from competing against the company should they terminate employment.
• Stability and predictability of revenue and cash flow
• Low customer concentration
• Other value drivers such as state-of-the-art operating systems

Kevin: I agree with Tom, but in the $2MM to $10MM EBITDA range, buyers are also looking for a high level of preparedness. Buyers are laser-focused on the quality of the management team and level of customer concentration.

What’s the biggest obstacle for owners in this segment of the market?

Tom: That’s easy: the owners themselves. Too often they negotiate directly with potential buyers who are much more sophisticated and knowledgeable about the sale process, and who use experienced deal attorneys and investment bankers. To overcome this obstacle, it is critical that these owners level the playing field by retaining experienced deal attorneys and investment bankers before they talk to any buyer.

The second biggest obstacle is the business. Most are not camera-ready because it takes time, talent, and commitment to prepare a business for sale. Before a company goes to market, owners and their advisor teams must have executed their plans to enhance all value drivers. When advisor teams include a transaction advisor (business broker or investment banker), that person not only shares knowledge of the sale process, but contributes real world knowledge of what buyers are looking for.

Kevin: Most private equity firms do not have a management team waiting in the wings. If an owner’s team is not top-notch both professionally and personally, a private equity/financial buyer will either pass or subject management to a rigorous professional assessment and background check. Clearly, it behooves owners to run background checks on all their important employees long before going to market.

When a company in the $10MM to $100M+ range lacks a stellar management team or has a customer concentration issue, a strategic buyer may be a solution. Often, strategic buyers are not as concerned with high customer concentration because their existing customer base spreads the risk. Similarly, they may already have experienced, proven management poised to fill any void caused by the seller’s departure.

How does an owner attract a strategic buyer?

Kevin: The most effective, least time-consuming way of doing so is to work with an experienced investment banking firm to conduct a controlled auction sale process. By bringing multiple competing buyers to the table simultaneously, the controlled (or competitive) auction maximizes a seller’s chances of receiving top dollar and closing the deal. An experienced investment banker will know how to attract the best strategic buyers without disclosing the identity of the seller.

How are buyers behaving in the marketplace today?

Kevin: Buyers are offering companies with $2 million to $10 million in EBITDA increased EBITDA multiples over historical norms. This not only means more money for sellers, but also significantly more scrutiny in the form of due diligence. The reason for the greater scrutiny is the greater risk financial buyers/private equity incur when they have to pay more and invest more of their own capital. I’m seeing financial buyers/private equity groups spending more than $1 million on due diligence alone.