Acquisition in Water and Sewerage Pipe Maintenance Space

March 30, 2021

by a searcher from INSEAD in London, UK

Hey SF,

I am looking at a deal in the Water and Sewerage Pipe Maintenance Space and wanted to check if anybody had any familiarity/expertise within the space?

Target is a regional player with decent clientele, some contracted revenues, above-average industry margins (appx. 20%) based on seller discretionary earnings) and low debt. They also have underground electrical wires maintenance contracts (ISP /telcos) but that forms <15% of the revenues.

One possible red flag for me was the lack of middle management in the company - CEO and COO are majority shareholders (both looking to exit for non-business reasons but COO is willing to stay on for 9-12 months) and both are very involved in the sales and tendering process. Also noticed the company is quite 'asset light' as most machinery and equipment is leased/hired as per the requirement of the projects. Is that normal?

What are the other major considerations / red flags to delve into during the initial due diligence process before getting an LOI out?

Any thoughts or insights would be thoroughly appreciated.

Reply by a searcher
in New York, NY, USA

Don’t mean to sound like a Debbie Downer (and this is merely my amateur two cents). As a searcher without significant industry experience, I would be extremely leery of buying ANY business where the 3 senior-most people are all leaving (COO staying for 9 months doesn’t change that). Having weak middle management is very common. Even MM PE firms run into that problem all the time, let alone small founder- or family-owned businesses that searchers tend to look at. I honestly don’t think I’ve ever met a single small business for which I came out thinking “oh wow they have a really strong and deep bench of middle management layer”. (I mean, if I had that for my business I would never sell; I’d just promote someone and go enjoy the cash flow as a passive/absentee owner.) So your conservative assumption going in has to be that you’ll have to replace all three of those people somehow. That’s really hard to do, and no matter how well you plan that out, even if you have candidates identified to come in with you, it’ll still be a major risk that you can’t “bound” because of your lack industry experience and expertise, especially given this is an (at least somewhat) technical business. For a typical highly levered search deal, this situation scares the heck out of me. Too many unknowns that can go wrong. Again, hate to pour cold water on your deal, but rather speak bluntly to be helpful.

Feel free to DM me if you’d like to hear about my own experiences or chat further. Best of luck!

Oops, just realized you meant the top 2 are leaving not 3. So that’s not quite as extreme, though my suggestion of general caution remains. Make sure you have a thoughtful plan on how to replace two full-time owner-operators while you’re learning a new business, and make sure you have a back-up plan in case plan A fails. Certainly try to structure you deal with as much seller note / contingent payments as possible. Spend a lot of time in DD focusing on what the CEO and COO and everybody else do exactly, and map out who will lead/manage/assist with which functions. Just like the other posters suggested. Also think about retention plan for the other employees (weak of not, you can’t afford to immediately lose the middle management post closing). Lastly, I wouldn’t worry too much about the business being asset light, it could actually be a good thing, as long as there’s some sustainable barriers to entry. Best of luck.

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