When does it make sense to pursue a business with relatively low margins?

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by a searcher from University of Virginia-Darden - Darden School of Business
in Washington, DC, USA

1yr ago

When does it make sense to pursue a business with relatively low margins?

I've reviewed a number of LMM deals in the past few months where the business seems fundamentally strong: long history, outstanding customer reviews / reputation, well-known brand in the community. However, SDE margin leaves little room for error for an independent searcher, even leaving in generous add-backs (pre-LOI).

In the spirit of NOT chasing the proverbial unicorn, when does it make sense to pursue this type of deal. Here are some of the items on my list:

- Seller has taken their foot off the gas (low working hrs).

- Obvious efficiencies: founder-led business without any professionalization.

- Seller managing the business to minimize taxes (potential positive in dd?).

- Extensive direct experience in the sector.

- Partner with someone who can visualize realistic improvements.

- Strong preference to operate in that sector or business.

In any case, it seems like a bit of a turnaround scenario, which is not the generally recommended ETA model. But in a world where there are no absolutes or unicorns, I'm trying to keep an open mind.

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reply by a searcher 1yr ago
in Anchorage, AK, USA

It depends, but for an good answer. buy with low margins If its in the same realm of your business and bolt it on. Then cross sell and gain more market share in your location. Hope this helps!

reply by an investor 1yr ago
from University of Pennsylvania in Claremont, CA, USA

If the margin is lower than its peers, it could indicate something about its operational efficiency or competitiveness. However, its margin is in par with industry average, then the worry about a low margin is the low ROA/ROE, as well as the risk of running into negative margin and breaking covenants.