The Journal · Capital
Cash led, not credit led
A roll-up grows on term debt. An owner-operator can grow on cash, with a line of credit for timing gaps. Here's the test to run before you buy.
Omnira Partners · · 3 min read
A private equity roll-up grows on term debt. An owner-operator can grow on cash, with a revolving line of credit that covers timing gaps and gets paid down when the job pays. The difference shows up in the slow months.
Before you buy a competitor with a loan, run one test. Can the business you're buying pay its own note from its own cash flow, alone? If it can't, you're taking on a platform's kind of risk.
How the platforms run
A platform buys with term debt stacked on top of the businesses it already owns. Every acquisition adds a payment before it adds a truck.
When a fund buys the shop down the road, it isn't paying with that shop's cash. It borrows against everything it already owns, and the new shop's first job is to help cover the payment.
That payment is due whether July is hot or not. It's the same in February as it is in July, and the lender doesn't care which month the business is having.
What the payment costs
A payment that's due in a slow month gets made from somewhere. It comes out of price, headcount, or the owner's pocket. Customers pay more, the crew gets smaller, or somebody covers it personally.
That one fact drives a lot of what happens to a rolled-up trades business in year two.
The other way to grow
The owner-operator runs on cash. Profit funds growth. A revolving line covers the gap between paying crews on Friday and getting paid on the 30th.
The line is drawn for timing and paid down when the receivables land, so when the slow month comes, there's no fixed payment waiting for it.
Two kinds of borrowing
Term debt takes years to repay. The payment is fixed, and it's due in the slow months too.
A revolving line takes weeks to repay. You draw it for a timing gap and pay it down when the job pays.
Owners get into trouble when the two blur together. A line that never gets paid down has turned into term debt, without anyone deciding it should.
The first is how a platform grows. The second is how an owner sleeps.
SBA debt is still debt
The October 1 SBA rule change makes it easier for an established owner to buy a competitor. It makes an acquisition cheaper to enter. It doesn't make the payment go away.
A lender has to see at least 1.15x combined debt service coverage. That means the combined businesses bring in at least 1.15 times what the loan payments cost. It's the floor a lender will accept. It isn't a number to run your business at, because a slow quarter can take you under it.
The test
Run the target's own cash flow against its own note, alone. Leave your existing business out of it. Use the target's numbers rebuilt the way a buyer rebuilds them, which we cover in how a buyer reads your P&L, not the seller's summary.
If the deal only works with your current shop propping it up, you've made a platform move with a platform's risk. A bad stretch at the new business becomes a bad stretch at both.
Structuring for cash
We structure for cash. The financing gets mapped to the business's real cash flow before you sign, and the line is sized to the gap, not to the dream. We aren't a lender, and the lender decides any financing.