Growth potential and exit strategies for 'locally focused' businesses

May 21, 2020

by a searcher from Harvard University - Harvard Business School in San Antonio, TX, USA

Curious how do you guys view this matter and I appreciate any insights,

As I'm progressing in my search I'm looking at a lot of businesses that I believe have limited growth potential.
Most of the businesses I've seen are very geographically focused and don't necessarily have an offering that can expand beyond their area. Their addressable market size varies but ultimately my models show that even if their cash flows are decent, their exit potentials are low.

Ideally, the business would have the potential to offer its products/services elsewhere with no significant additional costs, but most of the time that's not realistic e,g: high-end cabinet makers/ most real-estate related businesses, local services, dealerships etc.

Outside of software, online services, e-commerce and manufacturing, how do you guys think about locally focused businesses, what weight does that have in your decision making and valuations etc?

Thanks.

Reply by a searcher
from Tufts University in Los Angeles, CA, USA

I agree with Michael's point - the materiality of this issue is based largely on your fund structure.

Self-funded searchers who utilize SBA financing effectively and are capable hands-on operators can still do extremely well investing in regionally-focused businesses. Taking a small business from good to great by upgrading systems and strategies while paying down acquisition debt is one of the clearest paths to creating equity value. It's a less exciting path for sure, but also one where you should have more control and a greater chance at success.

Conversely, if you're backed by investors whose expectations will only be satisfied if you hit a home run on exit, your landscape of deals is much smaller and entry multiples are higher. You're now competing with PE funds and family offices at their own game, so the path to success is murkier. In your best outcomes you're still going to make more, but I think the risk : reward picture is more skewed as well.

With the current degree of economic uncertainty (and as a self-funded searcher) I am only looking at the former types of deals at the moment.

Reply by a searcher
from University of Pennsylvania in Philadelphia, PA, USA

I feel like the key operative for any local or regional focussed business is getting the EBITDA up over $5MM+ with a solid corp governance structure. At that point, you have an asset that you can exit to any number of PE firms for. They could be employing a roll up strategy, hoping for a strategic exit, or just simply deploying capital to hit hurdles aided by positive leverage. The kiss of death for most regional businesses is lack of governance and management talent which would make them a viable PE target.

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