Why Am I So Lucky?
March 25, 2025 | Issue #116
Big Deal Small Business: Why Am I So Lucky?
March 25, 2025 | Issue #116
The original version of this post was published nearly 4 years ago — it has been updated for my latest thoughts & learnings.
This is a newsletter written by Kaustubh Deo // Guesswork Investing about acquiring & operating small businesses. If you are a new reader / new searcher, please start here.
Finding an Edge in Private Equity
What’s your angle? What makes you the best buyer for a business?
When I worked in private equity, we were always trying to find our “angle” on a deal. At that scale ($50M+ EBITDA businesses), private markets felt pretty efficient. You’re not going to grab an off-market deal before other firms have a chance to bid as well. The management teams/owners are fairly sophisticated, the deals are big enough to hire proper financial advisors, etc.
So, like everyone else, we do our due diligence and come up with a number we’re willing to pay. But before submitting the bid, we always asked the question “If our bid wins, why were we so lucky?”
The default answer is that we missed something in diligence and are therefore overpaying, unless proven otherwise.
So how do we prove otherwise? Below are three common types of edges I see: Value Creation, Smartest Buyer, and Financial Engineering.
Sponsor Information
Big Deal Small Business is sponsored by Live Oak Bank, a leading self-funded search fund lender.
To learn more, reach out to Lisa Forrest and Sarah Andrews at Lisa(dot)Forrest(at)LiveOak(dot)Bank and Sarah(dot)Andrews(at)LiveOak(dot)bank.
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Value Creation Edges:
We found a dynamite management team who can change the trajectory of this business. They have a particular game plan that we believe is differentiated.
We’ve built a great rapport with the existing management team and they want us to win (so our bid may win even if it’s in-line with or slightly below other offers) as they believe their equity will be worth more with us.
We have strategic partnerships (such as key distributors we work with in other deals) that allow us to grow or de-risk this business in differentiated ways.
Smartest Buyer Edges:
We previously owned a business in this sector, so we can underwrite the industry dynamics better than other buyers.
We’ve seen a specific risk present in this deal in prior deals, so we know how to manage it better than buyers.
Frankly, these are tough, tough positions to argue. But it is certainly doable, especially once a PE partner has spent 15-20+ years buying businesses in one sector.
Financial Engineering Edges:
Others aren’t valuing this weird non-core part of the business, which we think we can carve out and sell for real value.
We are offering a structured deal solution that allows us to pay more in exchange for better downside protection. Said differently, we’re willing to accept lower upside (because we’re paying more upfront) in exchange for higher downside protection.
We have differentiated M&A ideas (vertical / horizontal integration that others haven’t thought about as opposed to a simple roll-up) that can change the business profile.
We are bringing in a strategic investor into the deal who can provide strategic benefits.
Again, you’re competing with a smart market. Making these arguments is not trivial.
Finding Your Edge in SMB Buying
This question “Why Am I So Lucky?” applies to SMB too, but I see it manifest in a different way.
In SMB buying, I also see three flavors of edges, which are a bit different than in PE:
Financing Ability
Operational Ability
Diligence Ability
Let’s take these one by one.
Financing Ability
Small business deals often fall apart because the financing just doesn’t come together. A deal may have such specific risk that no lender or equity investor can get comfortable — it’s less an issue of pricing the capital, it’s more of a binary yes/no.
That’s rare in PE — businesses large enough for private equity buyers are generally stable enough that to find capital.
As a result, being a well-capitalized buyer competing with under-capitalized buyers is a real edge. Brokers & Sellers will value the deal certainty that comes with your LOI.
In theory, there should be a clear hierarchy here: Self-Funded Searcher (who needs SBA + investors)< Traditional Searcher < Independent Sponsor < Private Equity Fund < Individual Buyer (who doesn’t need SBA or investors)
In practice, decision-making power also matters — that’s where a self-funded searcher can differentiate themselves, even if they are a poorly-capitalized buyer.
While searching, I highlighted to brokers that I am the sole decision maker on a deal. I explain that while I will have to raise equity & SBA, I’m not beholden to any single investor or bank. So if one capital sources passes, I can move on to the next one until I find my financing.
Now in reality, traditional searchers can effectively do this as well, but in speaking to brokers, it sounds like traditional searchers have made a habit of blaming their Board (i.e. their investors) for when they back out of an LOI. The unintended consequence of this is that brokers often view traditional searchers as non-decision makers.
As a self-funded searcher, that swings some of the financing ability edge back to you. Or at a minimum, it ensures that it’s not a weakness. But in general, self-funded searchers do not have an edge in financing ability.
Operational Ability
Unlike in PE, SMB deals don’t usually come with a management team. The companies are also so small that it can be challenging to recruit a management team to start on day one.
In PE, we often found our new management team during the due diligence process itself — there was never an operating issue per se.
SMB deals tend to be too small or fragile for that. Either there aren’t sufficient systems in place, or the P&L just isn’t large enough to support a true manager layer.
As a result, a buyer with real operational chops, especially in the given industry, is a real edge.
As a non-operational buyer (when I was a searcher), I would look at a $750K EBITDA business that had an owner doing sales and say: “I have to earmark $120K for a new sales guy on day one.”
A searcher with real sales expertise might say, “I’m going to do the sales for the first year, grow the business, and then hire in.”
Between those two examples, the person with real sales expertise has an edge to win the deal over the person who doesn’t — they can pay more and still generate the same outcome.
The good news is that most self-funded & traditional searchers do intend to drop into the owner role on day one. But the owner role itself can look vastly different between SMB deals.
On the flip side, an independent sponsor or PE firm needs to find someone to run the business, which can be tough unless they have someone in mind already.
When I searched, I took advantage of that dynamic by painting myself as the best of traditional search & independent sponsor:
I have the financing capabilities & decision-making power of an independent sponsor.
But I can be the full-time manager like a traditional searcher.
So again, this is not an edge I had as a searcher, but I had a clear, concise narrative with brokers on how to assure them it’s not a weakness. But more fundamentally, I would never win a deal on this basis.
Diligence Ability
Every SMB deal has complexities, issues, and risks. These can much harder to wrap your arms around than a straightforward PE deal. You also have limited diligence resources & support (consultants, lawyers, accountants), so it really falls on the searcher to figure deals out.
For context, in some of my PE deals, we have spent more money on legal due diligence alone than the entire cost of the SMB I bought. Due Diligence in PE is a fundamentally different game than in SMB.
As a result, being good at diligence is an edge. In PE, we called it “racing to turn over stones.” Let’s say a deal has 100 potential risks you want to diligence.
If you can diligence 80 of them and leave some room for error on the other 20, you can pay more for a business than a buyer who only diligences 50 risks and needs to leave margin for error on the other 50.
Price is the primary way you leave room for error — the more sure you are about the risk profile of the deal, the closer you can pay to its expected value.
There are several ways to be good at due diligence:
Have a trusted deal team that knows this type of deal. My recommendations are here.
Have a strong fundamental understanding of business quality. That requires research — a lot of my blog posts are geared to this topic.
Focus in on one industry — the deeper you dive, the quicker & more accurate you’ll get as you see multiple deals.
Look for themes — everyone likes plumbing & HVAC, but do you know why? Do you understand what makes them a high quality search deal? If so, you can tease out the core principles, and then apply them as a rubric against totally different industries that are less popular. That’s a great way to figure out the next niche that buyers will like.
Truthfully, that is how I ended up in tree care — I dug into a few deals, and noticed a couple key principles:
Tree care contractors have repeat revenue (pruning & trimming), one-time revenue (tree removal & stump grinding), and recurring revenue (tree healthcare).
That is very similar to home services businesses that have a stable of high-quality repeat clients that occasionally leads to larger one-time revenue.
So as long as the tree care business I find has a focus in pruning or tree healthcare, the business quality rhymes with what I saw in other popular home service industries, despite each project technically being a one-off.
Ultimately, the tree care business I bought had a 65%+ repeat revenue rate. Today we generate 75%+ of our revenue from pruning or tree healthcare.
Stepping back out — when I was a searcher, I viewed this as my key area of differentiation. My background as a fundamental, institutional investor had allowed me to build up this skill over hundreds of deal reps.
As a result, I chose to leave my stated industry filter wide open, rather than guiding brokers to specific niches. I wanted to be that filter because I knew I could do it efficiently and I could use it to find a pocket of unexpected value.
Conclusion
As a searcher, it’s worth reflecting on what your edge is. The list above is non-exhaustive, it’s just example to get your brain going.
But if you take anything away from this post — ask yourself why you’re so lucky to win a deal. For me, it was never going to be my operational ability. It wasn’t my financing ability either, though I worked hard to ensure that didn’t seem like a weakness.
For me, the edge was ultimately a combo of diligence ability and willingness to take on owner transition risk.
What is it for you?
Let me know your thoughts, I’m always curious to hear your reactions & feedback. I’m sure there are lots “edges” in SMB buying that I’m missing in my framework above. I’d love to hear them.
Just hit reply to this email or find me on Twitter.
Thanks,
Kaustubh // Guesswork Investing