Buy at 4x, Sell at 10x: What You Need to Fund Your First Buy-and-Build Acquisition

Few strategies in the lower mid-market are as elegant, or as widely underestimated, as buy-and-build. The premise is simple to state and demanding to execute: acquire several small, profitable companies at modest earnings multiples, combine them into a single larger group, and sell that group a few years later at a materially higher multiple. The gap between the price you pay going in and the price you achieve coming out is the multiple arbitrage, and it is where a great deal of the value in these strategies is created, with successful integration and synergy realisation the essential partnering component.

This article outlines what you need to buy your first business as the platform for a buy-and-build, and in particular what institutional lenders want to see before they will fund you.

The prize: multiple arbitrage

Small companies with, say, £1 million or less of EBITDA typically change hands at low multiples of earnings, often below 5x. They are perceived as riskier: dependent on one or two key people, less diversified, exposed to the loss of a single customer, and harder to sell on. A larger group with £5 million to £10 million of EBITDA is a different proposition entirely. It offers scale, diversification, professional management and a far wider universe of potential buyers, and so it commands a much higher multiple, frequently 10x or more.

The arithmetic is compelling. Assemble several businesses bought at around 4x and, simply by combining them into a credible group, the same stream of earnings can be worth 10x or more on exit. On £5 million of combined EBITDA, that is the difference between roughly £20 million and £50 million of enterprise value, before a single pound of organic growth or cost synergy is added. That re-rating, achieved through consolidation, is the essence of the strategy. Although buyers of these groups want to see well integrated businesses too.

The fuel that lets you pursue it at pace is debt. Our lenders specialise in providing finance to entrepreneurs embarking on UK buy-and-build strategies, and they are willing to lend against the right earnings. But they are exacting about what they will fund, and understanding their requirements before you start is the difference between a swift credit approval and a slow, frustrating decline.

A typical first transaction

Consider a realistic first step. You identify one to three complementary businesses with aggregate last-twelve-months (LTM) EBITDA of around £2 million. You agree an average entry price of, say, 4x EV/EBITDA: high enough to bring the sellers to the table, low enough that the cash you must fund on day one sits comfortably inside what a lender will support. That values the group at roughly £8 million.

Rather than pay the full £8 million in cash on completion, you structure the consideration so that only part of it is paid up front:

• Day-1 cash consideration (60% of £8 million): £4.8 million

• Deferred, rollover or earnout consideration (40%): £3.2 million

• Estimated transaction fees: £0.6 million

• Total day-1 funding requirement: £5.4 million 

The day-1 cash consideration is the amount the sellers receive on the completion date. Setting it at around 60% keeps the sellers happy while holding the day-one funding requirement to a level a lender can support. The remaining £3.2 million is paid over time, as rollover equity in the enlarged group, deferred consideration, or performance-related earnouts linked to revenue or EBITDA milestones. This achieves two things at once: it reduces the cash you must raise on day one, and it keeps the sellers financially invested in the group's continued success.

Transaction fees, here estimated at around £600,000, cover your own solicitors, the lender's solicitors, the lender's due-diligence costs and Langdon Capital's capital-raising success fee. Added to the £4.8 million of day-one cash, that gives a total day-one funding requirement of £5.4 million.

How much a lender will advance

How much debt you can raise depends principally on the target's sector and the quality of its earnings. Lenders size the loan as a multiple of EBITDA, known as opening leverage, or debt/EBITDA. As a working rule, for business-to-business, non-technology sectors with genuinely recurring revenue, whether from contractual customer relationships or from revenues underpinned by regulation, lenders will often advance up to 3x. On £2 million of EBITDA, that is £6 million of day-one debt, comfortably covering the £5.4 million required. Where recurring revenue is weaker, up to 2x, or £4 million, is more typical, and the structure has to flex: a lower day-1 cash consideration percentage coupled with more deferred consideration, or more of your own cash equity injected on day-1.

Two constraints govern the whole exercise. The first is the lender's maximum opening leverage. The second is the debt service cover ratio (DSCR), the headroom between the cash the group generates and the cash it must pay out in interest and principal. Critically, the DSCR must be maintained throughout the forecast period of the financial model, and under the lender's stressed case scenario. A structure that breaches covenants cover in year two under the stressed case scenario will not secure credit approval.

The ingredients you need

Beyond the numbers, lenders are underwriting a team and a plan. The following are the ingredients that, in our experience, move a first buy-and-build acquisition from an idea to a funded transaction.

One to three targets with around £2 million of combined EBITDA. The more EBITDA you can assemble on day one, the deeper the pool of lenders willing to back you. Around £2 million of aggregate LTM EBITDA is roughly the level at which you begin to attract the institutions with the greatest credit appetite and the most flexible structures. Below that threshold, the lending universe thins quickly.

Your own equity, or implied equity. Lenders expect the founder to have capital at risk. That can be cash you inject on day one, the completion date on which the loan draws and the acquisition SPAs complete simultaneously. It can also be implied equity: value you have already created in a business you previously acquired/founded, measured as the growth in its LTM EBITDA between the day you bought/founded it and the day we begin your capital raise. Either way, the lender wants to see that you win when they win, and that you lose before they do.

Targets with high quality of earnings. This is the single most important test. In short, lenders lend at the highest Debt-to-EBITDA multiples to companies with the highest quality of earnings. What defines quality of earnings?

1. Recurring income. Income can be recurring due to subscriptions collected through direct debits or an industry regulation forcing customers to spend on your target customers products or service (e.g. annual health and safety inspections and follow on purchases of replacement health and safety equipment that fails inspections). If your target company doesn't have either, then is it on long-term framework agreements with large customers, where it sits on preferred-suppliers-lists with difficult qualifying criteria and where the framework agreements are reviewed infrequently (e.g. every 4-5 years). Failing recurring revenues and framework agreements, does your target company have long average customer lifecycles, which indicate repeat business, despite revenue not being recurring due to regulatory-compliance-driven spend, subscriptions or preferred-supplier-lists.

2. High revenue visibiity. Can you demonstrate to and convince a lender that your target company will earn the same or more revenue in the next 12 months as it did in the last 12 months? Recurring revenue inherantly demonstrates this. In the absence of recurring revenue, customer contracts proving future customer spend can demonstrate this.

3. Low customer concentration. What percetage of your target's annual revenue is constitutited by its top 10 customers? Is there overreliance on one customer? The lower the percentage, the better.

Sector expertise on your management team. Lenders will want to see that you or at least one of your co-founders has significant expertise in the sector of the companies you'll be acquiring. If you want to acquire a business in a sector with a high quality of earnings and which is ripe for consolidation, but in which you cannot demonstrate sector expertise to a lender, then that is not the end of the road. You simply need to find a co-founder, with the same buy-and-build vision and goals as you, who does. This could be an experienced employee or current business owner who sees acquisitions as a means to scale and achieve more. If you cannot think of other ways, try advertising on LinkedIn for a co-founder - you will be pleasantly surprised at the volume of responses you receive.

A COO who has integrated businesses before. Buying more than one company at a time introduces integration risk: systems, staff, culture and customers must all be brought together without dropping the ball operationally. Lenders mitigate this by wanting to see an experienced operator on the team, ideally a chief operating officer with around twenty years of experience integrating smaller companies into larger groups. This single hire can be the difference between credit approval and a polite decline.

A group FD or CFO to own covenant reporting. Institutional debt comes with covenants, financial tests you must report against on a regular basis. If you do not already have one, a capable group finance director or chief financial officer is essential to produce accurate, timely reporting and to manage the lender relationship over the life of the facility. Lenders take considerable comfort from knowing that a safe pair of hands owns the numbers.

Business continuity through the sellers. A small company is often inseparable from its founder. Lenders want the sellers to remain with the business for at least a year after completion, with genuine incentives to stay and perform: consultancy agreements, rollover equity in the group, and earnouts tied to revenue or EBITDA. Aligned vendors protect customer relationships, institutional knowledge and, ultimately, the cash flows that repay the debt.

A solicitor to paper the deal. You will need a corporate solicitor to draft the heads of terms with each seller and, in due course, the share purchase agreements (SPAs). Good legal counsel keeps the transaction moving and protects you where it matters. We are happy to suggest firms that our clients frequently work with.

Quality of earnings: what lenders are really testing

This factor deserves its own section due to its importance to lenders and your prospects of securing financing.

Everything a cash-flow lender does comes back to one question: how confident can I be that this business will generate enough cash to service and repay my loan? Quality of earnings is the shorthand for that confidence. To ensure lenders have the appetite to back you, target businesses that score well on the three tests below.

First, recurring or recurring-like revenue. In descending order of preference, the strongest position is contractually recurring revenue, where customers are bound to keep paying, or revenue underpinned by regulation, where an external rule effectively compels the spend. Health and safety businesses are a good example: commercial building safety hardware must be inspected annually and replaced where they fail, so the revenue recurs whether or not the customer would otherwise choose to buy. Failing that, revenue secured through a framework agreement with a large customer, where you sit on a preferred-supplier list (say, one of ten approved suppliers) for a multi-year period before the framework is re-tendered, and where the barriers to joining that list are high. Failing that, a long average customer lifespan, of the order of five to fifteen years, so that even without a contract, customers demonstrably stay.

Second, high revenue visibility for at least twelve months. Can you say, with evidence, that the business is almost certain to earn a similar or greater amount over the next twelve months than it did over the last twelve? Order books, contracted backlog, renewal rates and historical retention are the kind of evidence a credit committee will look for.

Third, low customer concentration. The smaller the share of total revenue represented by your largest customers, the better. If the top ten customers account for a modest proportion of revenue, the loss of any one of them does not threaten the group's ability to service its debt. High customer concentration is one of the most common reasons a lender hesitates.

What lenders will need from you

Our lenders are global multi-billion-pound AUM institutional investors who have funds which specialise in financing "sponsorless" (not backed by a PE fund) buy-and-builds. Before they will issue credit-backed term sheets, they need to see two things, each prepared to an institutional standard.

A professional financial model. It should be monthly, with three years of historic figures and a five-year forecast, comprising fully integrated income statement, balance sheet and cash flow statements, and consolidated across all of the acquisition targets. This is the artefact against which the leverage ratio and DSCR are stress tested across the entire forecast period.

An information memorandum. This is the structured document that tells the investment story and presents the business, its market, its management team and its numbers. We provide our clients with a full information memorandum checklist once they engage us.

How we help

Langdon Capital provides a capital-raising service. We hold direct relationships with the key decision-makers, including CIOs, heads of direct lending, partners, managing directors and fund principals, at leading institutional investors with multi-billion £/$/€ of assets under management, and we give our clients swift, direct access to that market. We know what these investors look for, and we work alongside you to ensure that everything they need is prepared before we take you to market.

Assemble the right ingredients, and a first acquisition stops being a standalone deal and becomes the foundation of a group worth many times the sum of its parts.

Q&A: Key terms explained

Q: What is a buy-and-build (or roll-up) strategy?

A: A growth strategy in which a platform company acquires a series of smaller businesses in the same or adjacent sectors and consolidates them into a single larger group, aiming to sell that group at a higher earnings multiple than the price paid for the individual acquisitions.

Q: What is EBITDA?

A: Earnings Before Interest, Taxes, Depreciation and Amortisation. It is a common proxy for a business's underlying operating profitability and the figure against which acquisition multiples and debt are usually measured.

Q: What does LTM mean?

A: Last twelve months. LTM EBITDA is the EBITDA generated over the most recent twelve-month period, used as the current run-rate of profitability.

Q: What is EV/EBITDA?

A: Enterprise Value divided by EBITDA. It expresses the price of a business as a multiple of its operating profit and is the standard way to compare acquisition and exit pricing. Buying at 4x and selling at 10x means paying four times EBITDA and selling for ten times EBITDA.

Q: What is multiple arbitrage?

A: The value created by buying businesses at a low EBITDA multiple and selling the combined group at a higher multiple. The larger, more diversified group is re-rated upwards simply by virtue of its scale and quality, independent of any growth in earnings.

Q: What is opening leverage (debt/EBITDA)?

A: The amount of debt drawn on day one expressed as a multiple of EBITDA. A lender advancing 3x against £2 million of EBITDA is providing £6 million of opening debt. It is the primary measure lenders use to size a facility.

Q: What is DSCR?

A: The Debt Service Cover Ratio, the ratio of the cash a business generates to the cash it must pay in interest and principal over a period. Lenders require the DSCR to stay above a minimum level throughout the forecast, ensuring the borrower can always meet its debt payments.

Q: What is day-1 cash consideration?

A: The portion of the purchase price paid to the sellers in cash on the completion date, as opposed to amounts deferred, rolled over or paid later through an earnout.

Q: What is deferred consideration?

A: Part of the purchase price paid to the sellers at a later date rather than at completion, reducing the cash a buyer must fund on day one.

Q: What is an earnout?

A: Additional consideration paid to the sellers only if the business achieves agreed future milestones, typically linked to revenue or EBITDA. It bridges valuation gaps and keeps sellers motivated to perform after the sale.

Q: What is rollover equity?

A: An arrangement in which the sellers reinvest part of their sale proceeds as equity in the acquiring group, aligning them with its future performance rather than taking all of their consideration in cash.

Q: What is implied equity?

A: Value a founder has already created in a business previously acquired, measured as the growth in its LTM EBITDA between the date of purchase and the start of the capital raise. Lenders may recognise this as founder equity at risk in place of, or alongside, fresh cash.

Q: What is quality of earnings?

A: A measure of how reliable and repeatable a business's profits are. High quality of earnings, underpinned by recurring revenue, strong visibility and low customer concentration, gives lenders confidence that future cash flows will service and repay the debt.

Q: What is a framework agreement and a preferred-supplier list?

A: A framework agreement is a multi-year arrangement under which a large customer approves a limited number of suppliers to provide goods or services. Sitting on the preferred-supplier list gives a business privileged, recurring access to that customer's spend, usually until the framework is re-tendered.

Q: What is customer concentration?

A: The degree to which a business's revenue depends on a small number of customers. Low concentration, where the largest customers account for a modest share of revenue, reduces the risk that losing any one customer would impair the group's ability to repay its debt.

Q: What is a covenant?

A: A condition attached to a loan, often a financial test such as a maximum leverage or minimum DSCR, that the borrower must satisfy and report on periodically. Breaching a covenant can give the lender rights to intervene.

Q: What are heads of terms?

A: A short document setting out the principal commercial terms agreed between buyer and seller before full legal documentation is drafted. It frames the deal and guides the drafting of the share purchase agreement.

Q: What is a share purchase agreement (SPA)?

A: The definitive legal contract under which the shares of a target company are bought and sold, setting out price, warranties, conditions and the mechanics of completion.

Q: What is an information memorandum?

A: A structured document prepared for prospective investors and lenders that presents the business, its market, its management and its financials, and forms the basis on which they assess whether to provide capital.

Q: What is a financial model in this context?

A: A monthly, integrated projection of the income statement, balance sheet and cash flow, typically covering three years of history and a five-year forecast and consolidated across all targets, used by lenders to test leverage and DSCR over the life of the facility.

Enquiries

For further information, please contact info@langdoncap.com

About the author

Sabbir Rahman is Managing Director of Langdon Capital. He has held prior roles with Morgan Stanley, Lazard and Deutsche Bank. He has executed over £200 billion in notional value of debt, equity, M&A and derivatives transactions with global corporates, private equity funds and financial sponsor groups.

About Langdon Capital

Langdon Capital raises debt and equity for businesses with EBITDA between £2 million and £20 million from private credit funds, banks, private equity firms, special situations funds, family offices and venture debt funds. We raise capital to fund acquisitions, organic growth and turnaround situations. We hold direct relationships with key decision makers including CIOs, Heads of Direct Lending, Partners, MDs and Fund Principals at leading multi-billion £/$/€ AUM global institutional investors and provide our clients with swift, direct market access.

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