Investing in small and medium-sized enterprises offers major advantages and can deliver exceptional returns, but to get there, you need access to a wide range of options to analyze so you can find the best opportunities.
In a market segment with a highly fragmented set of players and a lack of transparency, access to information is vital, yet it can be difficult to obtain and become a major obstacle in the search for opportunities.
Likewise, as an investor, it's essential to properly define your strategic approach and the objectives you have when taking on a deal, the proposed transaction structure, and, when analyzing opportunities, to carry out a thorough study of all the relevant variables from different angles.
This increases the transaction's chances of success, helping you find the best opportunities, maximize the return on your investment, and capture any synergies that may exist, which are a differentiating factor in inorganic growth.
The importance of the investment thesis and defining objectives
To find the best investment opportunity, you first need to clearly and properly define the objectives you expect to achieve with the deal. You also need to specify the capital available to invest, so you can narrow the search for opportunities, and set out the strategic framework for the transaction, in line with each investor's profile, track record, and expectations.
The best way to do this is to set out all of this information in a document known as the investment thesis. This document is essential for capturing the investor's core objectives so you can start filtering and narrowing down the options that will undergo exhaustive analysis to a manageable number. All of this makes origination and analysis more efficient, so time and effort are spent wisely.
Preliminary analysis and identifying opportunities
Once you have a well-defined investment thesis, the next step is to identify potential target companies.
To do this, some common and highly relevant steps are:
- Determine target markets/services: Analyze different sectors that may be worth investing in, based on the investor's experience, growth sectors, and current valuations. Within these, study a large amount of information, such as business models, macroeconomic projections relevant to companies in the sector, revenue growth and EBITDA, or commercial margins, among others.
- Identify M&A candidates: Identify potential candidates that could meet the strategic financial growth objectives and the other variables set out in the investment thesis. You also need to make preliminary estimates of the companies' valuations, using multiples or DCF models, to understand whether they fit the intended investment.
Ultimately, the goal is to determine whether the acquisition is viable given the owners' price expectations and whether that price is reasonable according to the investor's parameters (that it isn't excessive or in a sector considered overvalued).
Analysis, due diligence, and validating interest
Finally, once one or more opportunities have been identified, you need to carry out a detailed study of all the relevant elements to confirm a company's potential and validate the decision to invest.
- Assess the financial and strategic position: An assessment focused on volume, revenue, costs, and the balance sheet. A preliminary financial analysis is carried out, based on the accounting and financial information the company has and any that can be obtained by other means.
- Carry out the valuation: This involves assessing the target's value, selecting the structure that would allow the organization to achieve its objectives, and developing an offer. Initially, this takes the form of a letter of intent (LOI, Letter of Intent), or a non-binding offer ( NBO, Non-Binding Offer), which sets out initial terms for price, method and timing of payment, and transaction structure.
Given the expected return, the valuation, and therefore the offer, needs to be in line with the market price, which is harder to determine for private acquisitions than in other cases, such as liquid, easily comparable financial assets.
- Carry out due diligence, negotiate a definitive agreement, and execute the transaction: The investor or buyer must ensure a complete due diligence review to understand the issues, opportunities, and risks associated with the transaction.
- Review of the financial, legal, and operational position, as well as other specific aspects (technological, environmental…) where necessary.
As we explain later in other chapters, due diligence is a complex process that is crucial to the deal's success, since it ensures the buyer or investor has complete knowledge of the company in all its facets. That's why there are different types of due diligence, carried out by professionals specialized in each area.
The main ones are:
- Legal due diligence: focuses on analyzing all of the companies' legal and contractual information (customers, leases, suppliers, employees, etc.)
- Financial due diligence: studies and analyzes the financial position (sales by product/service, margins, projections, EBITDA adjustments, etc.) by reviewing the accounts, audit reports, management reports, and capital structure, among other things.
- Tax due diligence: focuses on the tax aspects of both the company and the deal to be carried out.
- Commercial due diligence: studies, from a commercial perspective, the risks and relevant variables of the business to be acquired, the market in which it operates, its position relative to competitors, its customer relationships, and its distribution channels.
In conclusion, finding the best opportunities when investing in small and medium-sized enterprises is no easy task, but it's far from impossible.
The keys are to have access to as many opportunities and as much relevant information as possible, ensure transparency among all the parties involved, and carry out the steps and analyses required at each stage of the deal diligently and effectively. Likewise, it's essential to optimize resources and streamline processes so you can focus on the opportunities that are truly worth pursuing.
That's exactly what we do at Deale: we help all kinds of investors access a large number of opportunities that fit their profile and objectives, and, thanks to the digitalization of M&A, we enable them to move much faster through each stage, reducing costs and adding value at every step of the process.
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