How do you weight business quality vs purchase price?

by a searcher from University of Pennsylvania - The Wharton School

3 years ago

In my experience working in mid-cap private equity, we think of a good purchase price as providing margin of safety, whereas in small business investing, I've heard the opinion that small business are so high risk and multiples are always fairly low (3-5x), so the only way to create margin of safety is buying the highest quality business you can find.

For me, I'm seeing some COVID-impacted companies in tough, mature industries that are being offered <2x cash flow due to some kind of forced seller. In my mind, eking out a few more years on these businesses seems likely, which means your risk of losing money is negligible even if the business is a zero after 3-4 years.

Curious to hear folks' thoughts on this? 

6 likes
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9 comments

searcher

Great question

3 years ago | like reply | 1 like

searcher from University of Pennsylvania - The Wharton School

Be very careful. Temporary distress vs. structural market change (product obsolescence, permanent customer preference shift, etc.) are different things and sometimes can be difficult to discern if you aren't an expert on the particular industry and the forces shaping it. If you detect the latter - I would solicit input from someone in the industry, but if the business and the industry or product type is dying, I would steer clear. Contrarian opportunities exist, the herd can be wrong. There is always constant change in the marketplace though, and business is always a battle to stay relevant and deliver great value to customers. A lot of businesses do go on the market because they have issues though. Some of those issues are terminal. In those cases, let existing owners ride it to zero.

3 years ago | like reply | 1 like

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