Direct Derek - Market Anatomy

Count the Buyers Before You Buy

2026-06-22T00:00:00+00:00

The most reliable buyer in finance is the one created by a spreadsheet.

They arrive in the final column, pay the selected terminal multiple, have financing arranged, and close on the exact date required to make the annualized return look respectable. Their punctuality is admirable. So is their immunity to lender nerves and second thoughts.

That buyer is mostly harmless in a liquid market, where continuous volume can absorb an ordinary position. In an owner-operated business or a thin public security, they become dangerous. The exit requires an identifiable counterparty with motive, money, operating competence, and a timetable that overlaps yours. "Strategic," "consolidator," and "owner-operator" are categories, not evidence.

Before deciding what an asset might be worth, establish who can actually pay the modeled value.

Market liquidity and transaction liquidity</h2>
Market liquidity describes the ability to trade quickly, in size, at low cost, without materially moving the price. Quotes, spreads, turnover, and some measure of depth are observable.
Transaction liquidity asks a different question: can the whole position, or the whole business, be transferred on acceptable terms?
A thin public security may trade every day while offering no sensible exit for a meaningful block. The eventual buyer could be an insider, a strategic acquirer, another patient allocator, or someone compelled to transact by a mandate change. Until one appears, the quoted market may support only small pieces.
A small business is more direct about it. The buyer pool might consist of owner-operators, adjacent businesses, a few specific strategics, or another source of patient capital. Selling becomes a search process, with diligence, financing, negotiation, and closing risk attached.
Quoted is not executable. A displayed price can look like an exit sign while the doorway beneath it remains narrow enough for one cautious buyer at a time.

The toll reveals the capacity limit</h2>
The bid-ask spread is the price of immediacy. A market order demands liquidity and crosses the spread. A patient, non-marketable limit order supplies liquidity and may capture some of it, assuming someone eventually chooses to trade against it.
Take a security quoted with a 3% spread. Crossing it immediately costs roughly 1.5% on entry relative to the midpoint. If the spread has not narrowed on the way out, another 1.5% disappears there — a round trip surrendering about 3% before market impact, delay, commissions, or the opportunity cost of an order that never fills. In a name quoted 0.3% wide, the same round trip costs about a tenth of that. The spread is the entrance fee and the exit fee, quoted in advance and rarely read.
Then size starts working against you. The Amihud ILLIQ measure averages daily absolute return divided by daily dollar volume. A high reading means relatively little dollar volume produces substantial price movement: low deployment capacity in practical terms.
Empirical execution research finds that the average impact of a large order follows an approximate square-root relationship to its size relative to available volume. The coefficient and the volatility and volume inputs vary by asset and venue, so this is a shape rather than a forecast. Doubling order size raises estimated impact by roughly 41%. Quadrupling it roughly doubles impact.
There is no fixed dollar ceiling on capacity, and anyone quoting you one is selling something. The ceiling is whatever a particular market can absorb before your own buying reprices the asset against you, on top of the toll already charged at the door.

An owner-operator must be more than a noun</h2>
Calling someone an owner-operator does not make that person a credible buyer. What matters is what is actually being purchased.
One buyer wants control and a livelihood. Another wants adjacent territory, customers, or operating capability. Someone else believes personal involvement can improve the business. Those motives produce different price limits, financing structures, diligence concerns, and holding periods.
Qualify the pool by asking whether each prospective buyer has a specific economic motive, can finance the proposed exit value, is operationally capable of running the asset, and could transact within a realistic timetable. It also matters whether the candidates are genuinely independent or all vulnerable to the same constraint.
Transferability matters as much as earnings. Do customer relationships survive the current owner's departure? Can the systems function without one person's specialized knowledge? One credible buyer may make a transaction possible. Several independent buyers at least give price tension a chance. Ten names copied from an industry directory are still just ten names.
The question is not whether a buyer could conceivably own this asset. It is whether anyone wants it.

The buyerless middle</h2>
Growth can narrow an exit instead of widening it.
An asset can become too expensive for its natural owner-operator pool while remaining too small, concentrated, specialized, or inconvenient for institutions. Revenue rises, the terminal multiple stays obedient in the spreadsheet, and the number of credible buyers quietly falls.
Financing can make the pool look broader than it is. Ten nominal buyers relying on the same lender, the same collateral assumptions, and the same credit conditions amount to one effective source of demand. If that financing tightens, they tend to disappear together.
Vague strategic value deserves the same suspicion. A larger company might benefit from acquiring the asset without having a budget, an internal sponsor, or any real desire to transact. Conceivable fit establishes very little.
The entry discount has a way of reappearing at exit. Once an owner needs liquidity, bargaining power moves toward whichever counterparties remain. As the required price climbs, the buyer funnel tightens until the model is essentially negotiating with itself.

Build the exit map first</h2>
For each credible buyer class, map the economic motive, the financeable price range, the dependence on external funding, the operating competence, the conditions under which the buyer withdraws, the expected closing timeline, and the independence from other buyers' constraints.
Then stress the map. Apply the intended future exit size rather than today's purchase price. Rerun it under weaker financing and lower profitability. Shorten the sale timetable. Remove the obvious strategic candidate and check whether the asset can be divided if no single buyer can absorb it.
This is where position sizing loses some of its comfort. A five percent position tells you how much pain you might feel. It says nothing about whether the market underneath can absorb what you own.
A preference for capital-scarce markets makes this especially easy to forget. The whole doctrine is to operate where participants are few, which leaves no standing to act surprised when there are few participants left to sell to. Once the vague labels are crossed out, the remaining list is usually shorter: financed buyers with specific motives, relevant competence, and clocks that might align with yours.

Patience has limits</h2>
Longer-horizon investors are better suited to high-spread assets because round-trip friction is amortized over more years. That is the clientele effect described by Amihud and Mendelson: holding periods and illiquidity become matched in equilibrium, and expected return rises with the spread at a decreasing rate.
Waiting creates time for a buyer search, but it does not manufacture motive, financing, or operating ability. The pool's appetite and its timing can both be misjudged, and the exit map is built from the same optimistic assumptions as the entry thesis — it estimates the future behaviour of people nobody has met, using invented categories. Those uncertainties belong in both the price paid and the amount owned, because patience only helps if a buyer pool exists at the other end.
Replace the spreadsheet's terminal buyer with a shorter, uglier list, screened for motive, financing, operating fit, timing, and independent capacity. That list determines exit capacity. Exit capacity determines how much can be owned.
The doorway is easiest to measure before any capital has gone through it.

Fragmentation Among Owners Who Never Compare Notes

2026-05-05T00:00:00+00:00

Say a market has a thousand sellers and almost nothing has been said.

What matters is whether any two have seen the same transaction record, use the same definition of earnings, or price against the same reference point. A thousand commodity sellers connected to a common quote can form a brutally efficient market. A hundred owner-operators working from private books and local hearsay can stay mispriced for years.

Seller count is visible, so it gets the attention. The connection between sellers is harder to measure, and it matters more.

In a fragmented market, the first question is simple: what forces these prices to converge?

A large market can have very little capacity</h2>
Institutions need repeatable transactions, standardized reporting, and enough deployable volume to justify the machinery required to find an opportunity. Fragmented markets offer the opposite: many possible transactions, each requiring separate sourcing, diligence, and negotiation.
The capacity equation is roughly:
`usable capital = defensible opportunities × sensible size per opportunity</code>`
`A market can be enormous in aggregate and still offer almost no usable capacity. Ten thousand small businesses do not become one investable asset because a consultant added their revenue together on a slide. The capital remains trapped in ten thousand separate decisions.`
`This is where small size helps. The whole market does not need to reprice. One defensible mismatch, sized appropriately, is enough.`
`The catch comes attached. Scale the process aggressively and you start paying for the sourcing, diligence, and integration apparatus whose absence created the mismatch. Soon you have assembled a professional team to study a ledger that throws off a five-figure annual free cash flow.`

HHI counts firms, not conversations</h2> The standard concentration measure is the Herfindahl–Hirschman Index. Take each participant's market share as a percentage, square it, then add the results. Ten equal firms with 10% each produce 10 × 10² = 1,000</code>. One hundred equal firms with 1% each produce 100 × 1² = 100</code>. Two firms with 50% each produce 2 × 50² = 5,000</code>. Using the traditional concentration bands, an HHI below 1,000 is unconcentrated. Fragmented local-service markets can sit somewhere around 100 to 500. The National Restaurant Association counts more than a million restaurant and foodservice outlets; the Census puts NAICS 722 establishments nearer 700,000 — a gap that is itself an illustration of the definitional problem, and an impressive demonstration either way that people continue opening restaurants despite the available evidence. Low entry costs help reseed competition; many fragmented service businesses can be started for under roughly $50,000. None of that makes the economics attractive. Easy entry can keep returns low and bargaining power weak just as reliably as it keeps a market fragmented. The index also misses what matters. It cannot say whether owners share transaction data, keep comparable accounts, or know what a similar business sold for two counties over. A hundred firms can produce an HHI of 100 while leaving the buyer to determine what each privately means by "profit." The denominator has to be rebuilt</h2> Suppose five superficially similar operators turn up. There are five asking prices and five definitions of earnings. One owner pays themselves a market salary. Another runs personal expenses through the company. A third works sixty hours a week and reports the entire result as return on capital. Equipment replacement is current in one business and deferred in another. Lease terms and working-capital needs differ. One customer relationship belongs to the company; another leaves with the owner. Until those facts are normalized, there is no useful multiple to compare. The numerator is printed neatly on a page. The denominator is wandering around unsupervised. "Adjusted EBITDA" is supposed to fix this. Sometimes it does. Sometimes it means earnings before interest, taxes, depreciation, amortization, and questions. The target is not irrational sellers. It is isolated ones. Each owner may understand one operation and one territory better than any outsider ever will. What may be missing is reliable information about comparable transactions elsewhere. The edge, if there is one, comes from building a consistent comparison across several silos. It is modest and easy to overstate. A low asking price may reflect customer concentration, weak records, deferred spending, or goodwill that cannot be transferred. Without rebuilding the earnings denominator, there is no basis for calling the price cheap. The databases preserve the mess</h2> Classification systems are supposed to connect comparable businesses. Often they formalize the failure to do so. The Standard Industrial Classification system was last revised in 1987. The North American Industry Classification System replaced it in 1997 and is revised roughly every five years. Modern and hybrid businesses can still land in broad residual categories or split across codes that do not map cleanly. SIC 7389, "Business Services, Not Elsewhere Classified," historically absorbed activities ranging from telemarketing to computer services that now sit under several NAICS codes. The conversion is not one-to-one, so an automated crosswalk can omit a valid peer, include an irrelevant one, or break a historical series when the classification changes. The database looks precise. The categories underneath it are approximate. More filtering cannot repair transaction data that was never captured consistently. It gives the miscellaneous drawer a better search function. The obvious fix may remove the profit</h2> The institutional answer to fragmentation is aggregation: buy the scattered operators, centralize overhead, standardize reporting, and collect the difference. That works only if AC(large) < AC(small)</code> — if scale lowers cost per unit. Local service businesses can run the other way. Coordination overhead grows, bureaucracy arrives, and local agility or customer intimacy fades. A five-hundred-person organization does not necessarily mow a lawn, service an HVAC unit, or operate a dental chair more cheaply than a five-person shop. It does produce more meetings about how the work should be done. Persistent fragmentation may indicate that centralization has already failed, rather than that nobody has presented it with a sufficiently enthusiastic deck. Before capital moves, three answers are needed. Are comparable assets genuinely priced differently? Can the difference be explained? Can the asset be owned or integrated without importing costs that erase the discount? The last question kills most attractive spreadsheets. A buyer can identify a cheap asset correctly and still destroy the advantage by placing it inside an expensive structure. If aggregation works cheaply, the fragmentation — and the edge — will not last. The fence has a price on both sides</h2> Neglected markets are easy to be drawn to, which creates its own risk. It is easy to mistake inconvenience for value and bad records for an invitation to prove you are smarter than the seller. Some markets remain ignored because returns are poor, information is unreliable, or the goodwill disappears at transfer. Absence of attention tells you where competing capital is thin. It tells you nothing about whether the asset is any good. An exit that requires the market to become orderly is equally unfit to underwrite. Position size has to assume the same bilateral, private-ledger market on the way out that produced the entry. The opportunity survives because each piece is too small and too manual for large capital to standardize economically. That also caps how much can be deployed before the buyer becomes the aggregator, complete with overhead and diseconomies. Many owners, many private ledgers, no common price. Understanding one transaction well enough to leave the others alone is the whole requirement.