Size matters with LBO’s. The largest LBO market is comprised of target companies in excess of $1.0 Billion in sales. These are mostly public companies and as such command a different discipline than doing a deal on smaller private companies. This is a highly competitive market where deals are done by the largest of private equity groups or other large public companies.
The second group is called “middle market” and is a very broad range of medium sized companies that could be several hundred million in sales on down to $25 or $50 Million in sales. The boundaries are never completely defined and may even be wider that this range. Middle market companies are purchased by smaller PEGs, smaller public companies, well financed entrepreneurs and strong private companies. While the middle market is a less competitive environment compared to the large market, the deals in this segment still may attract significant interest from the larger players depending on the size and strength of the target company.
Finally, there is the small market. This can be zero to $25 Million in sales or zero to $50 Million depending on who you talk to. This market is where we want to do our deals. Who buys these companies? You, me, job-seeking executives, small companies, small investment companies. Fortunately, we lose most of the Wall Street crowd on this size deal. This is where the overlooked, undermarketed, unloved and undercapitalized deals are. This is our market.
So what does is this market look like? Well for one thing we may not want to go anywhere near as high as $25,000,000 in sales. We may only one a stay around $10,000,000 in sales or less. Indeed, we are not always concerned with sales. We often are concerned with the profit or as dealmakers call it, the EBIDTA. This stands for earnings before interest, taxes, and depreciation, but I will call it profit for sake of simplicity. Now, this number needs to be a certain size as well. It cannot be too small. On a $25,000,000 deal expect to see about $1 to $2,000,000 in the EBITDA. Usually we can expect to see about 5% of sales end up in profit. In some cases we can see as much as 10% of sales end up as profit. The deals should be pretty profitable on multi-million dollar sales numbers.
Now, when we get to the smaller deal size, we may only see $500,000 of profit or less. And so on $10,000,000 in sales we will get a somewhere between $500,000 to 1,500,000 dollars in profit. This is called our sweet spot: about $10,000,000 in sales with about $500,000 in profit or above. So in later posts we will discuss the process of defining our criteria. And our sales range and our profit range will be all part of the criteria. $25,000,000 in sales may be somewhat larger than we are willing to go. The reason for this is that the more expensive the deal, the more capital we have to deploy. So we try to keep our deal size down to a range where a leveraged buyout will help our cause, but not too big that we have a tough time acquiring the deal.
By understanding the buyout process, we can understand how to buy companies as small as mom and pop stores or as big as a private equity mega deal. I have engineered both mom and pop stores and management buyouts of subsidiaries of conglomerates using the same leveraged buyout techniques.
Unfortunately the biggest and smallest deals aren’t always the best. As easy as they are to acquire, the mom and pops do not generate much cash flow. So do not think that you can pull down a decent salary if the deal is too small. On the big side, divestitures of unwanted subsidiaries come your way once in a while but I wouldn’t hold my breath.
Companies with less than $1,000,000 to 2,000,000 in sales do not always generate a enough cash flow. Of course those with higher profitability can generate a great deal of cash even at small levels of sales. So when you are learning buyouts, and want to use LBO techniques, be aware of your sweet spot and ranges in which you want to participate.
