Growing Business in a Consolidated Industry

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September 22, 2019

by a searcher in New York, NY, USA

I'm looking at an opportunity with a business that has great fundamentals but operates in a small (but large enough) niche within a highly consolidated industry. It appears so far that the larger players don't service the niche this company competes in and would likely have trouble doing so. The industry is mature and the business has grown roughly 5% each year for the last 3 years and has been in business for 30 years.

Would you avoid this industry despite the business being solid? If you have operated in an industry with similar dynamics, what was your experience like?

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Reply by a searcher
from Harvard University in Chicago, IL, USA
How do you plan to finance the acquisition? If you're financing the deal primarily with your own funds and bank debt, than this is the perfect opportunity. For these (unfunded search) opportunities, the primary goal is stability over growth. Niche markets that large players eschew are perfect investment opportunities. They tend to be stable businesses, making it easy to repay debt (which can be as high as 90% of the transaction price if using an SBA loan). Your return will come primarily from leverage rather than growth.

If you've already raised a fund and/or plan to raise a material sum of outside equity, you'll be more incentivized to grow the business. In this scenario, a solid & stable business might not be the best opportunity if its growth is capped. This differs because you're financially rewarded through carry vs the accretion of your own equity investment.

Whereas a 20% unlevered yield would be a homerun in scenario 1 , due to the concentration of cheap debt (up to 90%), a 20% unlevered yield in scenario 2 may not net you a big financial return if you're heavily funded with equity.
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Reply by a searcher
from University of Virginia in Richmond, VA, USA
Perfectly stated in my opinion, Brian. Thanks.
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