Big Deal Small Business: Creative Industry DD Tips & HacksNovember 4, 2021 | Issue #49If this was forwarded to you, check out the archive and subscribe here.Housekeeping Note: I lost the battle with the Twitter algo and had to switch from Substack back to Revue. If this went to your spam folder. please move to your inbox and mark it as safe. Thank you!_______________________________________________________________In private equity, I have the benefit of a seemingly unlimited due diligence budget. When you're investing $100-200 million of equity at a time, you can spend a BIG number to get all questions answered.I'm not talking about Quality of Earnings or Legal Due Diligence or anything like that.I'm talking more about squishier, harder-to-define industry due diligence questions that ultimately matter WAY more than your QoE: Who are the winners & losers in the industry value chain going forward?How stable & resilient is the industry?What are the key trends in the industry?How fragmented is the industry?How does consolidation in suppliers or customers impact this business?In private equity (or strategic acquisitions), they can answer these questions with experience and connections. When those don't suffice, they can throw money at answering the questions. You can pay high-priced consultants to do market studies, you can pay for industry experts' time, you can buy useful data sets, etc.In search & small business acquisitions, we are generally less experienced in the target sector than the average PE partner or strategic acquirer. We often have fewer relevant connections as well.And we are extremely cost-conscious, partially due to deal size, but primarily because deal costs impact our runway.If you don't come from a "professional M&A" background, you may not realize just how much experience & money are spent on larger deals.Couple of anecdotes from my experience:I did a deal in 2020 that last sold in 2006. The lead partner I worked for had looked at the business in the 2006 auction and chose to pass on it. He has continued to follow the industry & business for the past 14 years. When it came back for sale in 2020, he pulled the trigger now that industry dynamics had shifted and the valuation was better. The sellers took a bath on their 2006 purchase; he had been right to pass on it the first time, and he had the conviction to buy it this time around.On a recent deal, we and our consultants did blind phone interviews (they didn't know who we were) with ~10 suppliers, ~25 middlemen/distributors, and ~25 customers. We also completed a 1,250-person customer survey.Most PE firms will budget 2-5% of the deal in deal costs. So a middle-market deal (say $30M of EBITDA at 10x = $300M EV) will generate $6-$15 million in deal costs. Even if you assume 90% of that is spent on lawyers, accountants, and bankers, it still leaves you with a couple million bucks in for just industry diligence costs.Look, we can debate whether all this is necessary or just false precision, but the reality is that searchers are playing with one arm tied behind their back when it comes to industry diligence.So, we have to get creative. I've written up a few ideas that have worked for me in the past - if you've got more, I'm all ears.
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Creative Industry DD Tips & Hacks
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Big Deal Small Business: Creative Industry DD Tips & HacksNovember 4, 2021 | Issue #49If this was forwarded to you, check out the archive and subscribe here.Housekeeping Note: I lost the battle with the Twitter algo and had to switch from Substack back to Revue. If this went to your spam folder. please move to your inbox and mark it as safe. Thank you!_______________________________________________________________In private equity, I have the benefit of a seemingly unlimited due diligence budget. When you're investing $100-200 million of equity at a time, you can spend a BIG number to get all questions answered.I'm not talking about Quality of Earnings or Legal Due Diligence or anything like that.I'm talking more about squishier, harder-to-define industry due diligence questions that ultimately matter WAY more than your QoE: Who are the winners & losers in the industry value chain going forward?How stable & resilient is the industry?What are the key trends in the industry?How fragmented is the industry?How does consolidation in suppliers or customers impact this business?In private equity (or strategic acquisitions), they can answer these questions with experience and connections. When those don't suffice, they can throw money at answering the questions. You can pay high-priced consultants to do market studies, you can pay for industry experts' time, you can buy useful data sets, etc.In search & small business acquisitions, we are generally less experienced in the target sector than the average PE partner or strategic acquirer. We often have fewer relevant connections as well.And we are extremely cost-conscious, partially due to deal size, but primarily because deal costs impact our runway.If you don't come from a "professional M&A" background, you may not realize just how much experience & money are spent on larger deals.Couple of anecdotes from my experience:I did a deal in 2020 that last sold in 2006. The lead partner I worked for had looked at the business in the 2006 auction and chose to pass on it. He has continued to follow the industry & business for the past 14 years. When it came back for sale in 2020, he pulled the trigger now that industry dynamics had shifted and the valuation was better. The sellers took a bath on their 2006 purchase; he had been right to pass on it the first time, and he had the conviction to buy it this time around.On a recent deal, we and our consultants did blind phone interviews (they didn't know who we were) with ~10 suppliers, ~25 middlemen/distributors, and ~25 customers. We also completed a 1,250-person customer survey.Most PE firms will budget 2-5% of the deal in deal costs. So a middle-market deal (say $30M of EBITDA at 10x = $300M EV) will generate $6-$15 million in deal costs. Even if you assume 90% of that is spent on lawyers, accountants, and bankers, it still leaves you with a couple million bucks in for just industry diligence costs.Look, we can debate whether all this is necessary or just false precision, but the reality is that searchers are playing with one arm tied behind their back when it comes to industry diligence.So, we have to get creative. I've written up a few ideas that have worked for me in the past - if you've got more, I'm all ears.