7 Key Considerations in Selling a Low-Margin Business

When marketed to the right type of buyer, a low-margin business that is consistently profitable and offers a broad customer base should bring top dollar.

By Robert Latham, M&AMI, CBI
IBG Business (Texas/Arizona)

A key measure of business value is EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization. Despite its broad acceptance as a reliable indicator, many business buyers unfairly impose a built-in bias against companies with EBITDA profit margins below 20%, commonly known as “low-margin businesses.”

While that bias can be discouraging to a would-be seller, overcoming it is one of the key ways that the M&A brokers at IBG Business bring value to a successful sale. In fact, from our standpoint, marketing a business in a low-margin industry actually shortcuts the process of identifying potential best-fit buyers. Here’s how.

Likely Buyers. A recent IBG article describes three main types of business buyers: individual buyers, strategic buyers, and financial buyers. While seven out of 10 deals handled by IBG involve financial or “professional” buyers, that ratio shifts significantly when the subject business is in a low-margin industry, as financial buyers tend to prefer businesses with EBITDA profit margins of 20% or more.

For a low-margin business, the most likely prospect is a strategic buyer – an established company that is actively engaged in the same industry (i.e., a competitor) or a related industry (perhaps a supplier) and sees the acquisition as a way to achieve a strategic or synergistic objective.

Strategic buyers might be attracted to complementary companies where there is little overlap, that offer one or more product lines that the buyer can sell to its existing customers, and, vice versa, that have customers to which the buyer can market their current lines.

Equally important, many buyers of low-margin businesses are, themselves, low-margin businesses. They know the industry, understand that low margins are typical of the industry (and not a company weakness), live with those margins on a regular basis, and appreciate the value of a company that grosses, for example, $20 million a year and consistently makes $1.5 million to $2 million. Also, strategic buyers are less likely to approach an acquisition with a high degree of leverage, which can mean more cash to the seller when the deal closes.

Buyers that fit that profile can be identified and vetted, allowing us to target-market the subject business to pre-qualified prospects that would benefit from a strategic acquisition.

DISTINGUISHING QUALITIES

Here are some common – and valuable – traits of low-margin businesses:

1. High-Volume Sales. To compensate for their slim margins, low-margin businesses typically strive for high-volume, high-frequency sales to recurring customers. This strategy can lead to substantial revenue and market share. Retail giants like Walmart and Amazon exemplify this approach, using their scale to attract a broad customer base, and they provide a model for owners of private low-margin businesses.
2. Customer Diversification. Potential buyers will be alert to signs of customer-concentration risk. In general, high-volume, low-margin businesses tend to have large, diverse customer bases, with no single customer accounting for more than 15% to 20% concentration – often much less. Because this quality will be especially important to a strategic buyer, sellers should be ready to provide a detailed customer list and purchase data, going back five years or more.
3. Operational Efficiency. To maintain profitability, low-margin businesses often prioritize operational efficiency. This focus leads to streamlined processes, reduced waste, and optimized supply chains. Over time, these efficiencies can result in cost savings and improved financial performance.
4. Innovation and Adaptability. To survive and thrive, low-margin businesses must continuously innovate and adapt. This necessity drives a culture of creativity and the development of new products, services, and business models. The focus on innovation can lead to long-term growth and sustainability.
5. Scalability. Low-margin models are often highly scalable. Once a business has established its operations and optimized its processes, it can replicate its model across different locations or markets with relative ease, driving growth and expansion.
6. Competition Repellent. The laws of economics being what they are, competitors can sniff out fat margins being made and are attracted to that market. Over time, often a fairly short period, competition will drive down prices to a low margin anyway, so why not keep them at bay?
7. Cash Flow Velocity. Related to operational efficiency, a key performance figure is the rate at which cash flows through a company. When a given dollar of profit flows through the business in less time, that improves the return on invested capital, and ultimately that’s what investors seek to maximize.

WE UNDERSTAND YOUR BUSINESS

With a track record of more than 1,100 successful closings, at an 86% closing rate (three times the M&A industry average), IBG Business is well-equipped to help you be fully prepared for the successful sale of your profitable business, regardless of where it resides on the EBITDA profit margin scale.

To start the process of marketing your company to a best-fit buyer who appreciates its value, contact an IBG Business M&A professional near you.