The “Leveraged Buyer”
Roscoe. on April 26th, 2015
I had some follow-on thoughts (using an LBO phrase) from yesterday’s article about the “superabundance” of capital in today’s financial markets. I hope it also gives you some insight into how to handle the changes in attitude towards today’s business buyers. First, a story.
Years ago when I started out doing deals and talked to many brokers there was one in particular than called me a “leveraged buyer” as if he were swearing at me. This was a broker who deemed me short of capital and would only show me deals that were qualified for leveraged buyouts – which weren’t all that many. These deals were sort of at the bottom of the barrel. These were turnarounds in some cases and other small deals where there were a lot of assets and and not so much in the way of profits. In other words the really good deals where capital was required would not be shown to me. Years later after a few deals, my image and sales pitch really didn’t change to the outside world. We would proceed to engineer and close good sized deals but I was still a leveraged buyer. The same broker would show me junk. I never changed the sales pitch except to let it be known that we had done some deals. I was making good money but I still did leveraged buyouts the same way. I can say with authority that even if you have done a few deals you are probably still doing LBOs the same way, you hate using your own money, you still must borrow money and still have to scramble for the equity slice.
Getting back to the broker, what he meant by leveraged buyer was that I was looking to do a 100% financing deal, i.e nothing down. If I had waived 20-30% equity in front of him I would not have gotten the cold shoulder. 20-30% is what the banks look for and is “well capitalized” by most standards. The point being that everyone is a leveraged buyer in some fashion and even those arrogant brokers who would love to close an all cash deal will have to live with leveraged buyers.
PE companies with a lot of capital do leveraged buyouts too, they did back then and they do now. They must do LBOs in order to get their return. The have traditionally looked for a 33% plus IRR and you cannot do that by paying all cash. Is it any easier for them to close a deal? Well they might find it easier to line up the capital but it isn’t easier for them to find the deals nor is it easier for them to cut a deal. Their environment is far more competitive than ours. The deals are often bid on at auction and they will compete against multiple other buyers with as much or more committed capital. The multiples are bid up to 10x or better. So make no mistake PE firms are leverage buyers just like we are.
So what does the LBO guy do to survive and how does he steer clear of PE firms? First, in most cases the average one man buyer, if he positions himself the way I teach, can get a look at just about any deal he/she wants. The buyer
disseminates his story, his background, his capabilities, is relatively transparent and he can get a look at most deals up to $50 Million in sales or better. Does he want to tackle those big deals? If he has the time and persistence to arrange them the answer is possibly yes. That is a decision he must come to early in the process. I am not an advocate of messing around with $50 Million deals unless you have a few under the belt. You will be outbid on most occasions. Our sweet spot is ebtida of $2mm and below. Those deals will not be sold right away and will be less competitive. We want to work with the seller who will not be shopping the deal to PE firms.
However, even deals below $2mm in ebitda will have some competition and sellers will not want you to walk away with their company without some skin in the game. If you are a 100% financing guy using no capital, you are a bootstrapper, like I was. 100% bootstrap deals are harder to find than they are to complete. I see many many deals every day that can be completed with 20-30% equity but buyers will turn them away because they want a fully leveraged deal. One must have a strong asset base and highly motivated seller for a bootstrap deal. So early on you need to make a choice, which am I, a bootstrapper or do I gather some capital to do a real deal?
Boostrapping does take longer. You can’t just assume that you run to the nearest broker and he will hand you a fully financed deal requiring no equity. You need to look under the rocks and go to places that others will not go. You need to talk to principals directly, accountants, lawyers, bankers and anyone who has the remotest connection to deals – because most them encounter deals they have no interest in but you do. I have seen deals done from many different and remote sources. Estate deals, deals from conglomerates, dogs from PE firms seeking to divest, deals from accountants whose clients want to sell, one-man starving brokers, partners, bankers, lawyers, asset based lenders, mezz, venture capital. These are all sources for great deals which is why you need to network in many areas. Conventional brokered deals are packaged so that PE firm might have some interest. They probably don’t but nevertheless the deals are often picked over and are still overpriced until enough time goes by and the seller becomes motivated.
Despite the ability to bootstrap deals, which still exists today, the best deals will probably be in the middle range. The deal that generates $1.0 to $1.5 Million in ebitda and where you might have to raise $400k in capital is likely going to be more lucrative than putting together a quasi turnaround situation which maybe makes $200k on $5.0 Million in sales and hoping that you can improve the operations. That said, money is certainly made on the latter, it just takes longer to find such opportunities. I will say this. Whenever I have looked hard enough I find, even through brokers, marvelous opportunities with fantastic asset packages, where the deal is overlooked, the seller is motivated and the deal is doable.
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