Any rule of thumb for PE folks looking at a potential investment and assessing the split between inorganic and organic growth?
What thoughts come to your head when you see a company that has too much inorganic revenue vs organic revenue or vice versa?
| +59 | Working on Juneteenth | 35 | 15h |
| +24 | From Public Equities to Private Equities | 4 | 5d |
| +22 | Hardest time I have ever seen to be a GP | 3 | 1d |
| +20 | How to Get on Career Track / Stay Post ASO years | 6 | 2h |
| +19 | Weighing exit from LMM PC/PE | 3 | 2h |
| Search Fund Internship Vs. Internship at my family's Family Office | 10 | 1d | |
| +15 | Healthcare PE | 6 | 2d |
| +15 | KKR comp for Principal | 12 | 8m |
| +15 | Anyone have intel on Aterian Investment Partners? Culture, Comp, Performance? | 9 | 4d |
| +12 | LMM groups within larger platforms? | 1 | 5d |
Career Resources
Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling.
When assessing the balance between inorganic and organic growth in a potential private equity investment, here are some key considerations based on the most helpful WSO content:
Scrutinize Organic vs. Inorganic Growth:
Red Flags with Too Much Inorganic Growth:
When Organic Growth Dominates:
Rule of Thumb:
Key Questions to Ask:
In summary, private equity investors should prioritize understanding the sustainability and quality of growth, whether organic or inorganic, and ensure that the company's strategy aligns with long-term value creation.
Sources: Private Equity: How to Analyze a CIM Effectively?, Private Equity Interview Questions - 13 Topics to Know, PE interview question - If you can only know 3 things for an investment analysis?, Thinking Like an Investor, Got this task during an Private Equity internship interview, how to handle it?
I think it depends a lot on end market (e.g., healthcare services roll-up versus SaaS versus industrials).
In SaaS-land, if I see too much inorganic, I usually assume (i) the core market is a slower grower and (ii) acquisitions might be loosely/minimally/sloppily integrated (which implies work and/or repositioning under my ownership and pro forma EBITDA is probably over-stated).
Thanks SaaSChimp! Enterprise SaaS was actually one of the key industries I was thinking of when making the post.
To dig in a little deeper and see if I fully understand, what do you mean by Pro Forma EBITDA is overstated? Like, you potentially think there are EBITDA adjustments that shouldn't have been adjusted out?
Perfect, yes. So their CIM/QoE probably could have a bunch of pro forma addbacks associated with cost savings (headcount consolidation, system reconciliation, etc.).
You’d want to dig in on whether the synergies have been enacted (and addbacks are just adjusting trailing figures for timing) or upcoming still. Platforms that have been moreso slapped together or unintegrated would be evidenced by a bunch of identified but unexecuted addbacks, which means it’s up to the buyer to finish the work. If it was so easy, the seller would’ve done it unless there’s some over-arching catalyst for an accelerated sale.
I see. So then, to take that logic back to your original comment and tie it up. Is that why you said one of the things you could assume a company with low organic growth to inorganic revenue growth is sloppily integrated at face value?
Because... after a SaaS add-on acquisition, you could assume that the combined enterprise SaaS platform company should gain some additional organic growth rate due to cross-sell and upsell synergies if you're not churning like a MFer.
Therefore, a company with low organic to high inorganic revenue may indicate (assuming there are no issues with a slow-growing core market):
i.) A need for further spending on integration for its previous add-ons during your holding period, and that the sell-side's EBITDA is overstated if it has already added back integration costs
ii.) There are inherent issues with the platform's ability to scale utilizing acquisitions because it was too hard for the previous owner to integrate them
I'd actually go a different direction and just say that if the underlying platform (and its market) are so amazing, organic growth should be there. M&A can be great for adding scale, diversifying end markets, accelerating product roadmap, etc., but if growth is all inorganic, it probably implies that the underlying market is unhealthy or saturated, hence the heavy reliance on M&A (versus focusing on just growing the main business). That's all I was suggesting.
On top of that, you want to look out for these jam job roll-ups that we discussed above that rely so heavily on M&A that they just slap stuff together and it's a pile of unintegrated junk with a bunch of multiple arbitrage for the seller. That was my only point. Some of the "brands strategies" have anecdotally fallen in this camp (i.e., building moreso an umbrella organization with minimal integration versus a truly integrated, high-performing platform).
SaaSChimp covered it well in their response, but one thing I'd add is to look for run rate addbacks. I.e. addbacks that supposedly were executed last month / quarter and now the seller is trying to get full year annualized credit for it. Sometimes these can be temporary addbacks (if they are real at all) and should definitely not be run rated.
In services you would probably do your best during diligence to strip out the inorganic revenue to see what 'organic' revenue growth truly is. The sell-side will do their best to obsrcure / give excuses to not view it that way lol
Rarely is it a good business if you have too much inorganic revenue unless it's a roll-up strategy and even then you'll want to see SSS/YoY organic revenue increase
I appreciate the input. I've definitely been in sell-side situations where we've downplayed the scale of inorganic growth relative to organic growth. Though I've never fully understood how a PE firm would diligence it, outside of looking at saying low organic growth = bad.
Perhaps an immature question, but are there any rules of thumb when looking at inorganic vs organic revenue growth (e.g., an investor wanting 1.5x - 2.0x of inorganic/organic average annual revenue growth)? I guess what I'm really trying to glean is an investment framework when looking at CIMs.
To answer your first question, we'd request the revenue and growth rates of the different business lines / units assuming they are still tracked separately (which they usually are if the acquisitions were done in the last 3-4 years).
We'd also try to construct separate P&L's depending on if sum of the parts was part of the thesis (ie we were planning to sell off pieces of the biz). This obv required separate diligence on each business line or product (I was in software / tech) and created a lot more work as you were effectively DD'ing multiple businesses.
Sint odit expedita repudiandae vel sequi. Animi nemo rerum doloribus reprehenderit sit. Est est voluptas modi quia voluptatem. Tenetur reprehenderit tenetur officia sed quisquam quaerat eveniet. Et ipsa aut maxime doloribus consequatur natus omnis et.
Qui ipsam aspernatur aut dolorum fuga. Fuga fuga sapiente fuga laboriosam debitis. Voluptatem impedit et asperiores qui et architecto tenetur reprehenderit.
Qui sequi ullam quia non. Iure explicabo doloribus dolor est est. Est aut nulla sed facilis ipsum. Eos sapiente molestias nulla fuga cumque officia aliquam. Corporis autem doloribus ipsum et aspernatur. Optio illum nihil vitae ullam similique voluptas ipsum. Aut iste culpa itaque ex voluptas quasi.
Error facere ea laudantium quis. Laudantium qui aut modi minus. Aliquam voluptatem unde sit sit nobis. Est iure numquam ea ad. Ullam laboriosam unde itaque sed sed sit.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...