Following my recent posts, a lot of people have reached out to me asking which verticals I’m most excited when it comes to a tech-enabled buy-and-build. The reality is that there’s many markets that would be great candidates for this strategy so there’s no straightforward answer. Rather than focusing on the ones that are happening today (e.g., property management, call centers, law firms, accounting etc.), I’d thought I’d share a framework that I find helpful to quickly assess the attractiveness of a given vertical.
The Framework
I’ve tried to distil the different points to their essence, but the reality is that there’s a lot of nuance and deeper learnings behind any of the points made. Each separate point could probably be a post in itself, and I could provide countless examples and anecdotes for each of them. My career has put me in the privileged position where I was exposed to some of the most successful roll-ups in (EU) history but also witnessed some of the largest failures from the side lines (point being it’s hard to summarise 10 years of learning into 1 short digestible post). If people are interested in diving deeper, feel free to let me know and I may create some dedicated posts
Market Structure
Favourable secular trends driving end-market growth - ideally you have an end-market that is expanding and/or AI is further increasing the TAM
Highly fragmented market (X000s of companies) with top players only having <5% market share - a plus if there’s external forces driving consolidation
The more homogenous the market and businesses (i.e., similar customer base, company structure and underlying processes) the better
Business Profile
High quality revenue (at least 80-90% gross retention through the cycle) - aggressive roll-ups +debt + business with fluctuating earnings = recipe for disaster
Preferably 5-10% YoY organic growth - it works with stagnant businesses but long-term organic growth will need to become a meaningful contributor to growth
Preference for B2B business who are essential to the operations of customers, yet only cost a fraction of their overall business expenses (’fly under the radar’)
Needs to be a ‘real business’ - avoid categories where business is directly linked to ‘experts’ or where you have ‘key man risk’ (e.g., dentists, GPs, etc.)
High cashflow conversion is important (i.e., avoid capex / working capital intensive businesses) - you cash flywheel is faster which fuels the buy-and-build
Value Creation - Operations
Needs to be an industrial logic behind combining various businesses - the synergies need to be real (beyond back office automations and efficiencies)
Need to properly integrate businesses and not build a ‘collection of kingdoms’ - easier for ‘simpler businesses’ with limited operations (and simple tech stack)
Value Creation - Technology
Need to find industries that are under digitised, and where preferably you don’t have strong software incumbents and/or PE backed consolidators
The value creation of the tech needs to be meaningful - you need to have a significant edge over a ‘traditional’ buy-and-build (e.g., 10% margin → 40% margin is amazing; 15→20% likely not enough)
Ideally you achieve this value creation fast → the faster you can show improved EBITDA, the faster you can get more leverage from the bank, the less equity you need to grow fast - your cash flywheel spins faster
Value Creation - Multiple Arbitrage
First-movers typically have an advantage because multiples are still ‘depressed’ - this advantage typically declines over time (competition + bigger assets trade at higher multiples)
Ideally, you focus on industries where entry multiples are low (e.g., 4-5x - which is true for most categories esp. if you buy smaller platforms). The latter reduces the amount of equity required to invest in the business, and meaningfully impacts unit economics
Long-term, you need to build towards something that is meaningfully more valuable than the sum of the parts - scale needs to unlock something unique, which makes the overall platform much more valuable and commands a premium multiple
Keen to hear what the community thinks of the above framework. As you can hopefully distil from the post, I’m really excited about these playbooks. If you’re building in this category, please reach-out to pieterjan@northzone.com or comment below