Mastering Lower Middle Market Company Acquisition: A Comprehensive Guide for Executives

Written By: Gerald O’Dwyer the PE Guru 

Introduction 

For seasoned executives venturing into the realm of private equity (PE) financing, the lower middle market offers a wealth of opportunities. With revenues between $20 million and $100 million, these companies present a unique blend of growth potential and manageable risk. This guide aims to provide a comprehensive roadmap for executives seeking to identify, evaluate, and purchase these companies, with an emphasis on utilizing PE financing. 

Identifying Prospective Companies 

To make a sound acquisition, executives need to find companies that offer sustainable growth and profitability. Companies operating in fragmented markets are particularly attractive. A fragmented market is characterized by numerous small and medium-sized companies, without a dominant player. Acquiring a company in such a market allows for more room to maneuver, gain market share, and achieve scale through consolidation. 

The Importance of Add-ons 

Add-on acquisitions are smaller companies that a PE firm buys to merge with a larger platform company already in its portfolio. They are a valuable strategy for executives and PE firms to enhance growth, realize operational efficiencies, and gain synergies. Identifying potential add-ons early in the process can help formulate a long-term growth strategy and increase the appeal to potential PE investors. 

Key Questions to Ask Sellers 

Prior to making a purchase decision, executives should dig into the details of the prospective company. This involves asking crucial questions to gain an in-depth understanding of the business and its potential, including: 

• What differentiates your product/service in the market? 
• What are the growth prospects for your industry? 
• Who are your key customers and suppliers, and what is the nature of these relationships? 
• What are the company’s significant assets and liabilities? 
• How is the company’s cash flow, and what are the key financial ratios? 

Finding Owners and Building Connections 

A crucial aspect of PE deals involves finding and connecting with company owners. Utilizing networking platforms, such as Blackmore Connects, can be particularly beneficial. Blackmore Connects’ PE conferences facilitate dialogue between executives and PE firms, allowing executives to receive coaching, understand the intricacies of deal financing, and build relationships for potential collaborations. 

Knowing your PE Firms 

Identifying and engaging with PE firms that already show interest in your chosen industry is a strategic move. This approach increases the likelihood of finding a partner who understands your industry, thereby speeding up due diligence and improving the chances of securing financing. 

Value Creation Plan 

A value creation plan outlines how an executive plans to grow and improve the company post-acquisition. It is crucial to have a well-articulated plan early in the process. PE firms prefer executives who can demonstrate a clear path to increasing value, whether through revenue growth, cost reduction, market expansion, or other means. 

Understanding PE Deal Economics 

In a typical PE deal, executives receive a salary that grows with revenue, performance-based EBITDA improvement bonuses, and an equity stake in the company. The bonuses can either be taken off the table or reinvested for more equity. Additionally, executives usually receive a minimum of 5% equity. 

Over time, through effective management and leveraging the equity value can significantly increase. When the PE firm eventually sells the company (often after five to seven years), the executive’s equity stake could be worth much more, due to the combined effects of business growth, multiple expansion, and leveraging. 

Leveraging Blackmore Connects 

Blackmore Connects provides a platform where executives can network with PE firms, participate in coaching programs, and attend conferences. Their offerings can prove valuable for executives, especially those new to PE deals. They provide insights into how to connect with owners effectively, understand PE deal financing, and much more. 

Conclusion 

Navigating the world of lower-middle market company acquisition can be complex, but with careful planning and strategic decision-making, it presents significant opportunities for executives. By understanding market fragmentation, the importance of add-ons, asking the right questions, and leveraging resources like Blackmore Connects, executives can be well-positioned to unlock value in their acquisitions. Lastly, understanding the PE deal structure and economics will enable executives to make decisions that benefit both themselves and their PE partners.