J-Curve
November 09, 2020
by a searcher from Queens University in Edmonton, AB, Canada
Can anyone speak to their experience with the earnings J-curve in mid-market transactions? More specifically, a situation where the acquired company has a strong management team in place. TIA!
from Harvard University in Cambridge, MA, USA
(1) Negative surprises post-acquisition
(2) It takes a few years for the searcher to "figure the business out" and realize the best path to growth
(3) Investment in the platform (new senior hires, IT) to prepare the biz for growth
from The University of Chicago in Chicago, IL, USA
1. An increase in the cost of payroll and benefits resulting from i.) the elimination of wage inconsistencies among like employees; ii.) an increase in the employer-paid portion of employee benefits (more paid holidays / better healthcare coverage / new incentive bonus plan / etc.)
2. Increased administrative expenses with insurance being a good example. It is not uncommon for mid-market targets to be underinsured (no recent insurance reviews / liability coverage limits that are inconsistent with revenue growth / lack of business interruption insurance (if desired) / stale property values / etc.)
3. Cost of hardware upgrades yet alone implementation of new information systems.
4. Elimination / abandonment of rough-edge policies - "contractors" paid in cash / services provided to the company at below-market rates due to seller relationships / services provided by the sellers at no cost to the company that will not continue post-closing (use of other facilities for customer entertainment, etc.).
It is important to remember that many mid-market companies (typically family owned) do not operate in a manner consistent with the standards of professional investors. A company may be able to earn handsome profits by running lean-n-mean but can the model be replicated by investors who expect internal policies and practices to be consistent with "market" conditions? Substantive post-closing "surprises" that relate to historical performance (and not the economy in general) are more often the result of flawed diligence and/or deal structure.