Fairly often, our clients will highlight their company’s success by pointing out that they have “domineering market share” in their service area. Or that they “own their market.”
Or that they “get 90%+ of the area’s business” for, say, windows, trim packages, framing kits, components, and more.
That’s certainly a point of pride for any business owner. Through a combination of hard work, careful attention to competitive pricing, and unrelenting customer service, these market share dominators have patiently grown—and fiercely protected—their own backyard.
Now, take a minute to put yourself in the position of the acquirer on that call. The deal lead on the private equity team might hear the seller’s comment about domineering market share and make an internal note for their team, privately jotting something like this: “High market share = potential risk they can’t grow without capital expenditures (CAPEX) into new regions?”
Make no mistake, acquirers welcome high market share positions, but they also take that attribute with a grain of salt. Here’s why: Private equity acquirers—which are the vast majority of acquirers in the LBM sector—are acquiring companies for growth. If a private equity acquirer bought your company at five times of an adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) of $2 million, they paid $10 million for your operation. But if you, the seller, already have market share domination, it’s fair to ask: “Does the $2 million of adjusted EBITDA represent all that can be rung out of your service area?”
After three to five years under new ownership by the private equity group (a typical hold time), if there is no growth, the private equity group would be selling your company, more or less, for what it paid…unless, of course, the private equity group combined your $2 million adjusted EBITDA with five or 10 others, improving the portfolio holdings along the way, and sold the combined operations.
If you, the seller, have dominant market share the private equity team will likely be building financial models to predict how much CAPEX it will take to set up a satellite location in a new market; that CAPEX will almost certainly come from the balance sheet of the NewCo created by the acquisition.
The object of this expansion model is to clone the successful anchor location, and drive to dominate the new market in similar fashion. When the satellite location achieves a similar adjusted EBITDA (all things being equal) the combined adjusted EBITDA of NewCo is now $4 million. The private equity group can sell the combined locations for $20 million, doubling their money.
If you are preparing your company for acquisition, and you are lucky enough to have dominating market share, here is something to consider putting in your “deal book” (a.k.a. the CIM or confidential information memorandum): Work with your investment banker to create a 3-year growth plan for setting up operations in a new market, or even multiple new markets.
This plan should model real estate expenses, all expansion costs (new staff, required inventory, rolling stock, OPEX), and a market analysis of housing starts and repair-and-remodel regional forecasts. A key part of this plan should be realistically listing leverageable capabilities in the legacy anchor store that can serve the new store, thereby saving CAPEX. If you have done this work even before offering your company for sale, then you can loudly champion your dominating market share, while pointing out that it’s a great model on which to expand to the new location No. 2, and then, perhaps, to No. 3 and No. 4. The private equity group will likely recognize, and reward, the anchor location’s adjusted EBITDA, while having confidence that the go-forward growth plan (operated by the skilled legacy leadership that’s staying on) is already in place.
I’m sure a fair number of business owner readers of this column will think that it’s unfair that private equity acquirers will look askance at companies that are killing it on market share. But one of the reasons that successful private equity companies have the resources to acquire companies like yours is their dispassionate empirical analysis of your performance, what it will be, and what parts of your operation can be leveraged elsewhere.
