What private equity firms look for in platform acquisitions

Here is the formula for an attractive purchase candidate as a platform, and not all of these are absolute:

1. A strong management team that will remain in place and be incentivized after the purchase.
2. No reliance on a few customers. Any customer accounting for over 10% of sales can pose a risk. (This is not always a deal-killer, but it makes it more difficult to get higher multiples).
3. Reliance on a few vendors that supply goods can also be critical.
4. Organic and sustainable growth of revenues for four or more years.
5. Strong intellectual property protection and strong brand recognition.
6. EBITDA of more than $4 million and an EBITDA margin of 10% of sales or better. Some groups require over $10 million or more of EBITDA for platforms. Some groups look for smaller.
7. A low CAPEX threshold. The buyer doesn’t have to purchase a large amount of new equipment or assets to grow the business after the sale, and the annual requirement is not substantial.
8. High accounts receivable and inventory turnover. This facilitates the conversion of profits to cash flow more quickly.
9. The seller will reinvest some of the proceeds from the sale back into the company. I have seen a 20% reinvest yield, which equals the original purchase price after the PE group sells years later.
10. Audited financial statements on a GAAP basis are helpful, and so is a quality of earnings report.

Positioning your business

A list of add-on acquisitions that the seller can share with the buyer, because their goal is to expand through acquisition and get economies of scale. Contact me, Len Friedman, if you have any questions or are ready to sell your business.

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What is adjusted EBITDA and why it matters

Why remove one-time and unusual income or expense items? Because they distort the picture of how your business performs on a regular basis. Common examples include personal car leases, one-time legal expenses, or non-working relatives on payroll. If you’re valuing your company based on inflated earnings, you’re setting yourself up for a tough negotiation—maybe even a failed deal. Clean financials and a transparent breakdown of these adjustments make your business more attractive to serious buyers.

How to identify adjustments before the deal

Begin by reviewing your general ledger and tax returns. Look for any items that don’t directly support operations, like your Porsche, your cousin’s salary, or annual conference trips that are more vacation than business. Once you’ve flagged those, work with a valuation expert to quantify and document them. This process isn’t just helpful for selling. It can also give you better control over your financials, uncovering ways to boost efficiency and real profitability. Adjusted EBITDA is more than a number—it’s a reality check that makes you look good on paper and in person.

To dig in further, you may want to consider a quality of earnings (QofE) report. Contact me, Len Friedman, if you have any questions or are ready to sell your business.

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Not just about the numbers on the surface

While financial statements tell part of the story, a quality earnings report goes deeper. It looks at cash flow, revenue sources, margins, customer concentration, and unusual expenses. The goal is to present a clear, accurate picture of ongoing profitability. It helps buyers avoid surprises, sellers defend their asking price, and reps and warranty liabilities are avoided.

Supporting addbacks to EBITDA and reducing risk

The most crucial metric when selling control of a middle-market private company is the earnings before interest, taxes, depreciation, and amortization (EBITDA). This metric is used to apply a multiple to conclude an asking price. Most seller representative reports start with EBITDA per books and then add items such as:

• Officers Comp
• Officers Perks (Perquisites)
• Personal non-operating expenses, such as travel, meals, vacations, and other costs that are unnecessary for operations
• Non-recurring items

This report often comes up during due diligence. For buyers, it lowers risk and supports financing efforts. For sellers, it shows transparency and builds trust. It also helps resolve questions before they become deal-breakers. When both sides have clarity, negotiations go more smoothly.

Who prepares the quality of earnings report

A quality of earnings report should be prepared by an independent third party, usually a CPA firm with M&A experience. Generally, why not the existing accountants for the seller? It’s different from an audit or a simple financial review. Think of it as a deep dive into what drives the business’s economic health.

Contact me, Len Friedman, if you have any questions or are ready to sell your business today.

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Economic changes wrought by the COVID-19 pandemic and other factors drove historic global mergers and acquisitions (M&A) activity in 2021. As a result, experts expect 2022 to be another busy year for dealmaking — and turnaround acquisitions.

In many cases, M&A opportunities arise when a business adversely affected by economic circumstances decides that getting acquired by another company is the optimal — or only — way to remain viable. If you get the chance to acquire a distressed business, you might indeed be able to expand your company’s operational scope and grow its bottom line. But you’ll need to take due care before closing the deal.

Turnaround acquisitions

Although so-called “turnaround acquisitions” can yield substantial long-term rewards, acquiring a troubled target can pose more significant risks than buying a financially sound business. The keys are choosing a company with fixable problems and having a detailed plan to address them.

Look for a business with hidden value, such as untapped market opportunities, poor leadership, or high costs. Also, consider cost-saving or revenue-building synergies with other companies you already own. Then, assess whether the return on investment will likely exceed the acquisition’s immediate costs and ongoing risks.

Successful turnaround acquisitions start by understanding the target company’s core business — specifically, its profit drivers and roadblocks.

Suppose you rush into the acquisition or let emotions cloud your judgment. In that case, you could misread the company’s financial statements or misjudge its financial condition. Ultimately, you may devise an ineffective course of rehabilitative action. Hence, many successful turnarounds are conducted by buyers in the same industry as the sellers or by investors, such as private equity funds specializing in a particular sector.

Due diligence

During the due diligence phase, pinpoint the source(s) of your target’s distress. Common examples include:

• High fixed costs
• Lack of skilled labor
• Decreased demand for its products or services
• Overwhelming debt

Then determine what, if any, corrective measures you can take. Don’t be surprised to find hidden liabilities — such as pending legal actions or deferred tax liabilities — beyond those you already know about.

You also might find potential sources of value, such as tax breaks or proprietary technologies. Benchmarking the company’s performance against its industry peers can help reveal where the potential for profit lies.

Another critical step in due diligence is identifying cash flows, both in and out. Determine what products or services drive revenue and which costs hinder profitability. Does it make sense to divest the business of unprofitable products, services, subsidiaries, divisions, or real estate?

Implementing a long-term cash-management plan and developing a forecast based on receipts and disbursements is also critical. Revenue-generating and cost-cutting measures — such as eliminating excessive overtime pay, lowering utility bills, and collecting unbilled or overdue accounts receivable — can often be achieved following a thorough evaluation of accounting controls and procedures.

Reliable due diligence hinges on whether the target company’s accounting and financial reporting systems can produce the appropriate data. If these systems don’t accurately capture transactions and fully list assets and liabilities, you’ll likely encounter unpleasant surprises. Moreover, you’ll struggle to turn around the business.

Mergers and acquisitions

Parties to a business acquisition generally structure the deal as a sale of either assets or stock. Buyers typically prefer asset deals, which allow them to select the most desirable items from the target company’s balance sheet. In addition, the buyer receives a step-up in basis on the acquired assets, which lowers future tax obligations. And the buyer gets to negotiate new contracts, licenses, titles, and permits.

On the other hand, sellers typically prefer to sell stock, not assets. Selling stock simplifies the deal, and the seller’s tax obligations are usually lower. However, stock sales may be riskier for buyers because the business continues to operate uninterrupted. The buyer takes on all debts and legal obligations. The buyer also inherits the seller’s existing depreciation schedules and the tax basis in the company’s assets.

Current market conditions will likely continue to generate turnaround acquisition opportunities in many industries. We can help you conduct data-driven due diligence and develop a strategic M&A plan that minimizes potential risks and maximizes long-term value. Contact our RRBB accountants and advisors today.

© 2022

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