Deal Strategy

Distressed M&A means acquiring a business in financial or operational trouble. In the lower mid-market, the distress rarely arrives via a formal restructuring process. It shows up as a bank line being called, a key customer filing creditor protection, a cost structure that made sense at pre-inflation input prices but not today. The discount is real. So is the complexity. What has changed is the source of the distress. Through 2023 and 2024 it was post-COVID normalization and rate shock doing the damage. Today it is tariff exposure and supply chain fragility. Businesses in manufacturing, distribution, and industrial services that could not absorb the margin compression were the distressed targets in 2025 and for 2026. Why Lower Mid-Market Distress Is Harder Than It Looks? For businesses operating in this space, books are often in poor shape. The owner runs the business, with no management layer beneath. Customer and supplier relationships are informal. There is no restructuring / financial advisor. You are doing diligence on a company that could not afford to keep its accounting current while the clock is ticking on a landlord, a lender, or tax arrears balances. The buyer who wins here is not the one with the highest bid. It is the one who moves fast, structures cleanly, and knows what liabilities to stay away from. Where the Opportunity Sits Distressed deals trade at multiples that healthy businesses do not. A business doing $500K in EBITDA in a normal year might transact at 3x-5x in a competitive process. In distress, the same asset with the same underlying customer relationships and equipment might clear at 1x to 2x, sometimes less. The value is not in the distress itself. It is in the buyer’s ability to stabilize and normalize what the previous owner could not. Illustrative Example: A mid-size industrial parts distributor built its book around US-sourced components sold primarily into the Canadian market. When the March 2025 tariff rounds hit, the 25% US surtax on Canadian goods combined with Canada’s retaliatory measures on US imports created a bilateral squeeze. Landed costs on the distributor’s primary SKU lines increased roughly 18 to 22%. The business had thin margins to begin with and had not passed through cost increases fast enough to protect cash flow. By mid 2025, it was drawing on its revolving facility to fund operations and had breached a covenant. A strategic buyer in the same sector acquired the business through an asset purchase. Structure excluded the operating line balance and a disputed supplier payable. Purchase price came in at approximately 0.4x trailing revenue. The buyer had two things the target did not: an existing supplier relationship that partially substituted the US-sourced components and enough scale to absorb the transition period. The acquired customer relationships contributed to new contract wins within 90 days of close. Role Of QoE In a distressed lower mid-market deal, the QoE scope shifts. Liquidity runway, short-term cash visibility, and off-balance-sheet exposure take priority over a clean normalized EBITDA build. The focus is not trying to get to perfect information, but identifying what kills the deal or the business post-close. The QoE work needs to reconstruct gross margin on a normalized cost basis. It also needs to scrutinize inventory carrying values, customer receivable and supplier payable aging, and any balance sheet and off-balance-sheet exposures. Worth Discussing: If you are looking at a distressed deal, we would welcome a discussion around the QoE scope.

In mid-market M&A across the US and Canada, choosing asset versus share purchase can materially shift seller’s proceeds on exit. Most practitioners get this in theory. Execution is where it breaks down. The Challenge: In the US, on asset deals, buyers get a step-up in asset basis for better depreciation. A 338(h)(10) election offers similar benefits in stock deals but only for certain S-corps or subsidiaries, and it needs seller consent, sometimes resulting in a price bump for sellers. In Canada, asset deals provide higher capital cost allowance (CCA) on stepped-up depreciable assets. Sellers resist, on both sides, as an asset deal triggers tax at the entity level, often followed by a second layer of personal tax on distributions. Canadian sellers also lose the Lifetime Capital Gains Exemption (LCGE), now up to $1.25M per eligible shareholder for Qualified Small Business Corporation (QSBC) shares under post-2024 rules, available only on qualifying share sales. Why This Matters? What Good Execution Looks Like: Real life Example: A PE fund acquires a US-based industrial services business at $18M equity value. The Target carries $9M in NOL carryforwards, which the buyer models as a meaningful tax shield. Later it was discovered that two years ago the Target raised funds through a bridge equity round at depressed valuation which triggered an ownership change under IRC Section 382. Annual NOL usage is capped at equity value immediately before the change × long-term tax-exempt rate (~$200K/year). The $9M takes 40+ years to absorb, which means the expected benefit is practically gone. A tax due diligence would have potentially revealed this in a day. Share Your Experience: Have you encountered NOL or NCL restrictions, or a QSBC eligibility gap, affecting deal structure or pricing? How did you bridge it?

A “roll-up” (also called “buy-and-build”) is when an investment firm buys one main company, then adds several smaller companies to it. They target fragmented industries (ones with many small players) like HVAC repair or plumbing services. The strategy works because: The Challenge: About 70% of these consolidations miss their targets. Common problems include: Why This Matters?: When done well, these strategies can deliver 3-5x+ MOIC (Multiple on Invested Capital—how many times you get back what you invested) through: Best Practices for a Successful Rollup: Real life Example: Morgan Stanley Capital Partners acquired Sila Services (a Pennsylvania-based residential HVAC company) in 2021. Over the subsequent 3.5 years, they built Sila into a platform operating over 30 brands across the Northeast, Mid-Atlantic, and Midwest regions through a combination of add-on acquisitions and operational improvements. In late 2024, they agreed to sell the company to Goldman Sachs Alternatives. While specific financial terms weren’t publicly disclosed, the transaction demonstrates how disciplined roll-ups can create significant value in fragmented service industries. Share Your Experience: Building a roll-up? We’d like to hear about your integration successes and challenges.

The foundation of value creation in M&A begins before the deal closes: detailed 100-day plans developed before signing the purchase agreement. This pre-acquisition planning discipline enables faster integration execution and earlier realization of synergies. The Challenge: Most buyers focus on deal execution and financing, leaving post-merger integration planning to the post-close period. This approach wastes the critical first 100 days when organizational momentum and change readiness are highest. Real Deal Context: A SaaS company under private equity ownership needed to modernize its finance function and integrate multiple acquisitions. Rather than waiting until after closing, they embedded integration planning into their due diligence process. The team worked with external consultants to develop a comprehensive plan covering two critical areas: The implementation set up the client so that future acquisitions could be integrated easily, as the data model and processes were already in place. When they completed another acquisition shortly after, integration was seamless. The difference comes down to Day One readiness. In successful integrations, employees receive offer letters, benefits information, and system access on day one. HR and IT know exactly what needs to happen. Success Factors Action Steps: For your next acquisition, mandate that the 100-day plan be board-approved before signing the definitive agreement. If you had any areas that drove significant synergies on your last deal, we would love to know more.

In our last issue, we explored working capital pegs and debt-like items. This issue examines revenue and margin quality—the bedrock of any Quality of Earnings (QoE) analysis and the primary driver of enterprise value. What This Means: Revenue and margin analysis evaluates not just how much a business earns, but how reliable, repeatable, and profitable those earnings really are. It dissects revenue drivers (price, volume, mix), customer and product economics, and cost structures to identify normalized earnings. The Challenge: Reported sales growth and margins often mask underlying fragility. Common issues include: Why It Matters (and How It Impacts Valuation): Valuation in deals is usually anchored on a multiple of normalized EBITDA. If revenue is less recurring than presented or margins are overstated, normalized EBITDA comes down—and every turn of the multiple compounds that value impact. Beyond the level of EBITDA, quality of revenue and margins affects the multiple itself: In effect, revenue and margin analysis influences both sides of the valuation equation: the normalized earnings, and the multiple (risk and sustainability). What Does the Financial Due Diligence Analyze?: A robust due diligence systematically dissects revenue and margins through the following lenses: Real Deal Context: During a sell-side due diligence for a commercial services company, our analysis revealed significant revenue and outsized margins from COVID-related supplies (hand sanitizers, disinfectants, etc.) during peak pandemic months. We adjusted reported revenue by removing these non-recurring sales and the associated margins from the normalized run-rate, thereby presenting a credible view of underlying performance. Deal Mechanisms to Address Revenue and Margin Issues: When revenue or margin risks are identified, common deal structuring mechanisms include: These tools allow parties to share risk around uncertain revenue and margin outcomes instead of walking away from the deal. Are You Prepared? If you are contemplating a transaction or want a pre-diligence ‘health check’ around your business, we would be happy to discuss.

In our last issue, we covered Quality of Earnings (QoE), including a Net Working Capital example. This issue dives deeper into working capital pegs and debt-like purchase price adjustments. What This Means: Net Working Capital (NWC) is a negotiated lever that directly influences purchase price through the working capital peg. The peg represents the normalized level of operating working capital a business needs, and is negotiated during the due diligence exercise using the most recent 12–24 months average to strip out seasonality and unusual items. Closing NWC is measured as of closing date using preliminary estimates, with final true-up adjustment 60-120 days post-close. In a cash‑free, debt‑free deal, NWC is usually defined as current assets (excluding cash) minus current liabilities (excluding debt and agreed debt‑like items), and deviations from the peg at closing drive dollar‑for‑dollar price adjustments.​ In summary, If closing NWC < peg, seller pays buyer (decreases purchase price). If closing NWC > peg, buyer pays seller (increases purchase price). The complexity lies in deciding what belongs in “operating” working capital versus what should be treated as debt‑like. Long‑dated or non‑operating obligations—such as environmental reserves, large warranty provisions, certain deferred revenue, or tax exposures—often behave more like debt in economic terms. If they remain inside working capital, they can distort the peg and blur accountability for future cash outflows; if reclassified as debt‑like, they reduce equity value or are settled by the seller outside the peg. Common Challenges: Real Deal Context: One of our clients acquired an industrial manufacturing company in a cash-free, debt-free transaction where the target carried historical environmental exposure and longer-term product warranties. During our due diligence, we identified sizeable environmental and warranty reserves in “accrued liabilities”—treated as current liabilities and included in historical NWC. Management noted these obligations would resolve over years but argued they were part of normal operations and embedded in historical financials. The buyer pushed to reclassify them as debt-like items for the EV-to-equity bridge. The parties agreed to: This preserved buyer protection and seller economics without renegotiating headline value. Suggested Success Factors: Share Your Perspectives: Have you encountered a situation where reclassifying an item between NWC and debt‑like materially changed the deal economics? How did you resolve it?

What This Means: Quality of Earnings (QoE) is a critical due diligence exercise that goes beyond the numbers in financial statements to assess the true, sustainable profitability of a business. Unlike a standard audit that verifies historical accuracy, a QoE analysis examines whether reported earnings reflect the ongoing operational reality and identifies adjustments needed for a normalized view of performance. QoE reports have become essential tools for buyers, lenders, and investors. They uncover accounting irregularities, one-time items, aggressive revenue recognition, and hidden risks that could materially impact valuation and deal structure. Common Challenges: Real Deal Context: We recently advised a private equity firm acquiring a Pennsylvania based Document Management Software company. The QoE exercise involved extensive negotiations around the Target Net Working Capital (NWC Peg), with particular focus on deferred revenue treatment. Our analysis examined the cost-to-serve existing customer contracts against collected revenues to ensure the negotiated peg would provide the buyer with adequate post-closing liquidity and operational flexibility. We continued our engagement post-close to validate the final working capital settlement against the target. The NWC Peg (Target Net Working Capital) is a negotiated benchmark—typically based on historical averages—that represents the expected working capital level a business needs to operate normally. At closing, the actual working capital is measured against this peg: if it’s lower, the buyer receives a dollar-for-dollar purchase price reduction; if higher, the buyer pays more. This mechanism protects buyers from inheriting a business that’s been stripped of operating cash while ensuring sellers aren’t penalized for maintaining healthy working capital levels. Suggested Success Factors: Informative Content: In a recent video podcast, I explored the nuances of Quality of Earnings, essential deal considerations, the evolving role of AI in deal execution, and more. Watch the full discussion here. Share Your Perspectives: Quality of Earnings analysis is the foundation of informed deal-making, protecting value and building trust between parties. Have you encountered significant QoE findings that reshaped a transaction? We would be interested to know how you addressed the issues and moved forward.

What This Means: “Deal jumping” occurs when a new bidder makes a competing offer after a deal is announced or signed, presenting a higher or better-structured proposal. This can force boards, sponsors, and strategic buyers to reassess the deal, their fiduciary duties, and protections in place. In mid-market deals, these situations are less common than in large-cap transactions, but they do happen — especially when deal protections are lighter, financing is accessible, and a competitor sees strategic opportunity. Common Challenges:  Real Deal Context: Occidental Petroleum vs. Chevron / Anadarko (2019): Suggested Success Factors: Share Your Perspectives: Deal jumping and topping bids are high-stakes maneuvers requiring strategy, foresight, and solid legal guidance. Have you been on either side of a topping bid? We would be interested to know how you navigated through the challenges?

What This Means: ESG due diligence encompasses systematic assessment of environmental liabilities, social compliance obligations (labor practices, supply chain ethics), and governance structures (board composition, executive compensation). Unlike traditional due diligence, ESG risks often remain hidden until post-close, when remediation costs can exceed acquisition premiums. The Challenge: Acquirers face escalating regulatory expectations across multiple jurisdictions. Environmental liabilities—particularly remediation obligations and carbon exposure—create material financial exposure. Social risks including labor violations and supply chain exploitation damage brand value. Governance failures generate regulatory investigation risk. ESG issues often cluster in specific geographies or industries, creating concentrated risk profiles traditional due diligence overlooks. Why It Matters: Bad management of due diligence can lead to missed risks, extra costs, regulatory problems, or even losing the deal. Good management speeds up decisions, lowers risks, and builds confidence for closing and integration. Real Deal Context: Nestlé’s $7.15 billion licensing agreement with Starbucks (announced May 2018, closed August 2018) for perpetual global rights to market Starbucks consumer packaged goods and foodservice products illustrates the importance of ESG considerations in complex commercial transactions. Given both companies’ public commitments to sustainable and ethical coffee sourcing, acquirers in similar deals would need to assess: Critical Success Factors for ESG Due Diligence: Share Your Perspectives: Which ESG factor represents the greatest post-close financial risk: environmental liabilities, labor compliance, or governance risk?

What This Means: Managing due diligence means organizing many expert teams and tasks all at once, under tight deadlines. It requires smooth teamwork between financial, legal, tax, operational, and strategy specialists, clear communication, strict confidentiality, and quick problem-solving to protect the deal’s value and timeline. The Challenge: Handling dozens of advisors reviewing thousands of documents at the same time is very complex. You need detailed project oversight and strong coordination so nothing gets missed or delayed. Why It Matters: Bad management of due diligence can lead to missed risks, extra costs, regulatory problems, or even losing the deal. Good management speeds up decisions, lowers risks, and builds confidence for closing and integration. Real Deal Example: Johnson & Johnson’s purchase of Actelion shows how to do this well: they managed 15 teams, 200+ advisors, and 2 million documents in just 90 days. They held daily meetings, tracked issues live, and quickly addressed problems. The deal was even more complicated because Actelion’s research and development part was spun off into a new Swiss company during the process. In mid-market deals, while the scale is smaller, the same principles apply. Instead of hundreds of advisors, mid-market transactions typically involve smaller, focused teams, often up to 10 key advisors managing a handful of diligence workstreams. Strong project management and communication remain essential to keep the deal on track and protect value. Success Factors: The key is strong project management and good technology to keep everyone informed and solve problems fast. Planning early how the companies will integrate also improves results and keeps deal value safe. Share Your Perspectives: Dealmakers – feel free to share your tips and experiences managing big, complex due diligence projects.