The Adviser’s View
Jason Fraler, Founder, Anchor Peabody
We find ourselves giving out the same advice over and over again these days: Don’t sell today unless you have to. This advice applies here.
During the boom times, this business probably traded at 3.5 times to 4.5 times adjusted EBITDA, or approximately $3.5 million to $4.5 million. Even if we never see those lofty EBITDA multiples in the future, if the business can improve and achieve around $2 million in EBITDA in several years, it will be worth almost $7 million at the low range (3.5 times)! Clearly, if the client can stick it out, we are going to recommend doing so. This always isn’t the case, of course.
The current market valuation for a profitable business this size is net book value plus some amount of good will. This business has a lot of things going for it: Management team, a diversified customer base (low customer concentrations), high-margin products for sale, a great position in a market with a lot of upside, and they’re right there with the business metrics.
What is working against this business is its historic performance. Even with the management adjustments, adding back in some one-time events that affected performance from 2004 to 2008, we feel this business has underperformed from a profitability standpoint. We like to see businesses that operate in this segment around 8.0%+ adjusted EBITDA, as we can make the case to potential buyers they are paying for a top performer.
We would push for a net book value deal plus another $1 million in good will paid via earn-out (additional cash paid over time, based on performance). Our argument would be (i) the client doesn’t have to sell, (ii) you can only sell your business once, and our client is selling at the bottom of the market, (iii) we ran a discounted cash flow (DCF) analysis on the business, and expect a buyer to make 5.0 times their money on the business at our valuation. For a variety of reasons — which we would share with the potential buyer — we feel a strategic buyer can afford to increase the purchase price to entice the current owner to sell and still make a sufficient return on investment.
We would also try and structure the deal a little differently. If the accounts receivable is not purchased, it adds risk to the client, as customers are less likely to pay you because they don’t need you anymore. Regarding the real estate, the hardest thing to come to an agreement on today is the value of real estate. We suggest including some language in the purchase option, which values the real estate via a third-party appraisal at time of purchase.
Without a doubt, the seller should run a competitive process to maximize this valuation. We agree with Scott: Parker Lumber may be one of the best groups out there to sell to. However, this does not mean they are the only game in town — especially in Southern California.
Anchor Peabody is a private equity investment and M&A/debt advisory firm that focuses exclusively on the building products and construction industry.
Improving your company’s value
By Jason Fraler, managing principal, Anchor Peabody, LLC
We are recovering, but things are still slow. Many of you are starting to replenish your teams — holes created from the deep cuts you needed to make to survive, while waiting for the market to come back. Lots of you are talking up market share gains, gross profit increases and efficiency gains. A few of you are even getting back to expanding your business by opening a new location or via the selective acquisition target.
All very commendable activities, but how about: Beginning with the end in mind.
Many business owners in our industry are up in age and missed the opportunity to sell during the boom times. Then the bottom dropped out. Six years later, business is not great and it may be awhile until the market recovers to a point where owners will consider selling their business again.
As we put the pieces back together, in our opinion, one of the best things an executive or owner can be doing now to enhance shareholder value is to work on areas that can improve the value of the business later. As business gets better, it will become harder and harder to work on this, as all of our waking moments and energy are focused on executing within the operation. Why not now?
Here’s a partial list of areas where you can focus your efforts to improve valuation:
• A business with significantly positive EBITDA: Businesses with cash flow beyond “razor-thin” positive are valuable, as acquirers know that there will always be hiccups. Additionally, businesses with large cash flow increase the amount of debt a buyer can use to purchase the business — increasing their potential ROI and, in turn, your valuation.
• Size matters: Deals that require more than $10 million in equity will get the attention of financial buyers, increasing the competition for your transaction (higher demand). Also, larger businesses command a greater multiple of EBITDA because there are fewer of them (less supply) and, right or wrong, buyers consider larger companies to be less risky.
• Timing: Remember, bears and bulls do fine, and pigs get slaughtered. As the market recovers, those of you holding on only to sell later need assure history doesn’t repeat itself. Leave buyers with some potential “runway” in the market by selling before the market gets overheated again. Doing so will create more competition for the deal and ensure buyers won’t pull out for fear the market will contract. Also, keep in mind it can take six months or more to sell a business. Leave yourself some time.
Potential deal killers and areas that hurt valuation
• A business with negative EBITDA: There aren’t many, outside of the turnaround firms, that want to acquire a problem. We’re amidst the fifth or sixth year of a downturn, and the housing market is bouncing along the bottom. At this point, the consensus view is that barring some extraordinary circumstance (i.e. legacy lease expense), operators should have right-sized their business. Many hold the view that turnarounds rarely turn around; do what you need to do to stop the bleeding or you’ll pay for it.
• Poor management team or an owner who “is the business:” A business is its people, first and foremost. Examples of poor situations: Untrustworthy people, a team with a poor track record or the whole management team is leaving post-transaction — and taking the customer relationships with them out the door. Transition those customer relationships early and think about building the management team “bench” depth.
• Large customer concentrations: The most typical example here is a business that sells to the national builders. Some dealers have built their business around these customers only to walk into the annual vendor meeting one year and lose the account. Buyers like to sleep at night. Any customer representing more than 20% of sales is a potential deal-killer; diversify away from them if possible.
Where to go for help
By Jason Fraler, managing principal, Anchor Peabody, LLC
Opening your business is the single most important event in a company’s timeline. Deciding to sell your business is usually the second most important event, so it is valuable to understand who can help you in the process.
We see deals mentioned all the time in our industry publications: “Company A acquires Company B,” but have you ever wondered who are the people who put together these deals? Sometimes the answer is nobody — Company A calls Company B and the deal is consummated without a third party, but most of the time there is an intermediary involved. For the layman, these intermediaries can be broken down into two basic categories: business brokers and investment banks.
Most of us will only get one chance to sell our business; let’s arm you with the proper knowledge so that you can pick the right one and affect the best possible outcome.
The business broker
Business brokers facilitate the sale process for smaller companies that have less than $5 million in sales, and/or a valuation of less than $5 million.
Sale process: This is very similar to selling a home. A basic overview of the company will be written and distributed to interested parties. Brokers will sometimes list your business on sales and trading networks (often online). The burden of the sale process can fall on the company, depending on the broker.
Price: 5% to 10% of the sale price, with no upfront fees/retainer
Pros: Lower fees; no upfront cost.
Cons: Minimal transaction experience (in scope); typically play “matchmaker” for parties with limited deal expertise; risk for subpar “story communication” and can exhibit a tendency to market firms to a limited number of established buyer relationships.
The investment bank
Investment banks handle large or sophisticated deals, especially those companies that will benefit from their dealmaking expertise. Typically, companies with sales of $5 million to $500 million, and/or $2 million in recurring annual EBITDA (earnings before interest, taxes, depreciation and amortization) will hire what is referred to as a “boutique” investment bank (sometimes referred to as an M&A adviser).
Note: Companies that are larger than $500 million in annual sales will most likely seek the help of Wall St. or “bulge-bracket” investment banks. Most of the companies in our industry aren’t this large, so for discussion purposes, we will focus on boutique investment banks.
Sale process: This is a sophisticated and proactive process designed to create momentum toward a sale and a closed, competitive auction, which maximizes valuation. A boutique investment bank develops high-quality marketing materials, which properly positions the company and articulates the opportunity. Boutique investment banks highlight the value, considerations and risks of a transaction, while tackling “deal killers” early on. They remove the burden of the sale process from the company by bringing in qualifying buyers, regulating buyer contact with management and facilitating information flow, thus allowing business owners to focus on their primary task: running the business.
Price: A percentage of the sale price (2% to 5%) referred to as a “success fee,” depending on the complexity and size of the deal, with an upfront and monthly retainer. Retainer fees cover the boutique investment banks’ cost associated with the significant investment of time and effort required to run an effective sale process. Should you decide to stop the sale process for any reason, you lose the retainer fees. However, if you follow through with the sale, your retainer fees will be credited against the success fee. This dynamic gives the boutique investment bank an ability to recommend when to walk away from an offer, because their costs are covered.
Pros: Wall Street transaction acumen coupled with personalized, senior-level service; will properly “package” and communicate the business’ story/merits to the market; boutique investment banks may have industry expertise.
Cons: Higher fees than a business broker; Boutiques may not offer a full-range of services found at a large bulge-bracket investment banks (i.e. IPOs, exchange of public securities, etc.).
Here are some questions to ask of your business broker or investment bank, to help find out if they are right for you:
• How much industry experience do they have?
• What are the biggest challenges my business faces in a transaction, and how will they deal with them?
• Who is in their network of contacts?
• What is their typical transaction type?
• What is their level of involvement once we have signed the engagement?
• Do they have a clear plan to create momentum for a successful transaction?
• In what may be the most significant event of my businesses’ lifetime, am I giving the transaction the best possible chance to succeed by choosing this adviser?
• Have they offered examples of, and am I comfortable with, their quality of work?
• Will I like working with this person?
• Will this person offer honest and candid advice?
The sale process can be stressful, overwhelming, time consuming, inefficient and a task outside the core competency of the management team. Selecting the proper adviser for your situation is a key to a successful transaction in order to maximize probability of success, execute the transaction efficiently, and prudently optimize valuation and terms.