# Red Flags in Serial Acquirers ## Five categories, then a long list of tells REQ's framework puts red flags in five buckets, all of them about M&A strategy and management (REQ, Jul 2025, p.283): 1. Change in **M&A strategy** 2. Change in **financing** 3. Change in the **compounding trajectory** 4. Change in **communication style** 5. **Cultural** change And then a triage that matters more than the list: does the flag represent a **permanent fundamental change** (sell), a **temporary effect** (buy or hold), or only **negative price action** (buy)? (p.284) ## Structural red flags **Capital allocation** — extensive use of equity or debt to fund acquisitions. **Declining return on capital is the sign that the company is paying too much.** Turnarounds rarely succeed. **Synergies** — acquisition decisions should stand on standalone valuations and be accretive without restructuring or synergies. REQ avoids companies that justify acquisitions by pointing at revenue or cost synergies. **Ownership** — purely institutionally owned companies, often run at the sole discretion of a management team that owns no shares. **Management** — companies that guide the market on short-term earnings and play the beat-consensus-by-a-cent game; CEOs who spend too much time at financial conferences and investor events instead of with employees, customers and suppliers. **Targets** — few and large deals: more complex, longer diligence and integration, higher risk, **and higher valuations**. Also **passive sourcing** — working mainly through M&A advisors with a mandate to sell — versus active sourcing, where the acquirer contacts private companies directly. Active sourcing gets better prices. **Advisors** — programmatic acquirers build the skillset in-house. Using the Big 4 for financial DD on a small private company is a signal about how the firm thinks. Teqnion's Daniel Zhang, on why they source themselves: "Would one really like a situation where one can only choose a partner based on what a matchmaker sends you and then go on a date with the matchmaker sitting on the side of the table?" **Structure** — no decentralised model behind an aggressive growth target. ## The yellow flags — the accounting and disclosure tells This is the most immediately usable page in the deck (p.287–288): **Definitions drifting** - Different ways to define or measure **organic growth**, and changes in the definition. Proforma, last year's performance. - Companies that **stop disclosing organic growth** quarterly. - Proforma figures used more commonly. Increasing P&L adjustments for all kinds of costs. - Substantially increased **capitalisation of own work** in relative terms — which boosts EPS. **Aggressive net debt definitions** - Using a *four-quarter average* net debt. - Adjusting net debt for leases but not EBITDA. - Not counting certain debts (e.g. property holdings). - Not adjusting EBITDA for non-cash items like **revaluation of contingent considerations**. - Using tax credits to pay down net debt while excluding tax credits from net debt. - Adding proforma P&L to the net debt/EBITDA calculation but not the proforma balance sheet. - Interest costs under financing activities in the cash flow statement. **Behaviour** - Aggressive financial targets, and targets that keep being raised. - Large **insider selling alongside capital raises**. - Press-releasing several acquisitions at once, repeatedly. - **CEOs leaving shortly after a very large acquisition.** - Management or large owners bonused on **acquired volume** or on sales / ARR growth. - Earn-out structures that do not seem to benefit shareholders — e.g. 1× EBITDA p.a. for 5–7 years. - Press-releasing LOIs, sometimes ahead of share issues, sometimes later withdrawn. - Low transparency in M&A press releases, in purchase price allocations, and around contingent considerations. > [!danger] The composite signature > Absolute revenue target + equity-funded M&A + several deals announced together + organic growth disclosure quietly dropped + a net debt definition with three adjustments in it. Any one is noise. Together they are the deflating rollup described in [[Why Rollups Deflate]], one or two years before the market prices it. ## Shareholder communication as a signal REQ reads letters as a culture instrument (p.289–291, drawing on Cunningham's *Dear Shareholder*). The best ones are written by the CEO not IR; talk openly about failed investments; give no earnings forecasts; explain capital allocation priorities explicitly; state the succession plan; use the **same performance metrics every year** rather than cherry-picking; and discuss the limitations of accounting in measuring economic profit. > [!quote] Mark Leonard, Constellation Software, 2017 letter > One of the analysts who covers Constellation recently changed his perennial "sell" recommendation to a "buy". We lost one of our few critics. Companies get the shareholders they deserve: talk about quarterly numbers and you attract speculators. ## Why it matters This is the negative screen. Most of the money in this strategy is made by not owning the ones that break. ## Related - [[Acquisition-Driven Compounders MOC]] - [[The Compounder Screener]] - [[Why Rollups Deflate]] - [[Case Files - When Compounders Break]] - [[Self-Financed Growth and the Balance Sheet]]