The Anatomy of an M&A Market: Overview
“If we buy this business, how much EBITDA can we acquire prior to exit?”
It’s one of the fundamental questions sponsors ask us during diligence. TAM is often used to approximate the answer. After all, if your platform is only $50 million of a multi-billion-dollar market, why not accelerate growth and buy some of those billions for yourself? As it turns out, there can be many reasons why not.
TAM can tell you how many dollars are out there, but it tells you very little about how many are available to you. On its own, TAM is an insufficient answer to the M&A question.
Exit Insights has developed a better way to evaluate M&A potential with a simple two-component framework:
- The Actionable Pool: How many real opportunities exist?
- Execution Friction: How challenging will it be to execute on those real opportunities?
The Actionable Pool:
The actionable pool appears deceptively simple on the surface. More companies with larger revenues and higher margins mean more EBITDA available for acquisition. The key is defining and evaluating “actionable.” If you can’t or won’t acquire a business in practice, then it might as well not exist.
Actionable to us means a few things. First, is the company privately owned by the founders or management? Sure, you can (and likely will) acquire sponsor-backed businesses, but good luck getting enough deals at a price that supports multiple arbitrage. Second, does the company actually fit your mandate? Not in a “throw it against the wall and see what sticks” sort of way, but does it truly fit across products, services, channels, end markets, customers, distributor/OEM relationships, geographies, or whatever else is driving the thesis? It’s one thing to say there are thousands of pest control companies, but an entirely different thing to say there are fewer than 100 in the Southeast that are bootstrapped with more than $2M in EBITDA and focused on commercial customers. It’s why we’ve moved away from TAM and other simple top-line estimates that can be misleading. The true answer lies in the number of actionable targets you’d be willing to acquire at a price you feel comfortable with.
Execution Friction:
Question number two is the real secret sauce. Large markets that are difficult to execute in are a slog. Have funds made great returns in HVAC? Yes, of course, but how many more muddled along for the hold period until they couldn’t wait to get out? How many became frustrated when the companies they expected to buy traded at much higher valuations than previously estimated, and the ones left over had too many blemishes to fit the thesis? We help prevent groups from falling into that latter category by utilizing detailed insights to either guide them toward avoiding a space entirely or arm them with the execution plan required to land in the successful first group. If you’re committed to a competitive and challenging market, it helps immensely to know why it will be challenging and how to approach it. Our experience shows that a deep understanding of market dynamics improves both speed to close and the overall volume of deals.
What makes a challenging M&A market? We’ve narrowed it down to four main factors:
- Competition for deals (or the lack thereof)
- Complexity
- Known unknowns
- Idiosyncratic deal factors
Over the coming weeks, we will break down each of the factors. We will detail how we evaluate each, what we look for, and how we tie our findings to real-world execution implications. In the meantime, if you’re curious about any of the above or are evaluating a market that could benefit from this kind of thinking, shoot us a note. We’re always happy to talk shop and lend our expertise.