Top five concerns of sellers and buyers

October 25, 2017 John D. Wagner

The LBM Strategies Conference M&A panelists responded to your top concerns.

The recent LBM Strategies Conference in Dallas offered a dynamite mergers and acquisition panel made up of the top national buyers of lumber dealers and distributors. There were two panelists from publicly held companies, and two from private equity groups. No matter where panelists were from, there was a lot of agreement when they responded to questions and concerns discussed with the audience. Here are some highlights:

REAL ESTATE: Many lumber dealers want to sell their real estate along with their businesses. But acquirers aren’t really interested in your real estate. They are buying your business for the relationships and leadership you have put in place to generate cash flow and profitability. Sellers who stick to the notion that the real estate has to be part of the deal may find the deal stalled, and perhaps DOA. Start the process of preparing for acquisition by setting up a corporation to hold the real estate, and lease to back to the acquirer.

LEADERSHIP: Leadership continuity is key to maximizing the value of your business. Don’t put your business on the market and boldly announce that all the top executives are leaving. That approach will devalue your company…if you can even sell it. It’s important to work back a year or more to install leadership that will stay in place after the acquirer takes over.

CLEAR UP INVENTORY: One M&A panelist gave some great advice about cleaning up inventory before seeking an acquirer: “Don’t expect to be paid for old, stale, or slow-moving items sitting in your yards.” Beyond cleaning out old inventory, make sure you have digital systems to track and manage inventory. An acquirer will do a physical inventory during their due diligence, but demonstrating control over your inventory is a key for demonstrating you have control over your overall business.

CLEAR UP A/R: If you have A/R that is dated, that will reflect poorly on you, even though dated A/R is the fault of the borrower and not you. No matter the reason, you’d be well-advised to clean it up and have most accounts sub- 30-days net when you take the company to market.

HR: If your business is a family business, and you’ve been loose with HR policies (e.g. verbal employment contract, verbal promises of bonus, no formal harassment policies), get these formalized. If you’re running a tight ship that won’t require the acquirer to spend time and money to fix, it reflects well on you, and your value.

WORKING CAPITAL RATIO: At 1stWest, we typically advocate a working capital ratio (WCR) of 1.5/1 of assets to liabilities, e.g. $1.50 on hand for every $1 in liability. Although that 1.5/1 is a good baseline, some panelists said that there is no hard-and-fast working capital ratio; it is negotiated on a case-by-case basis, so that the business has ample cash for operations.

Given how seasonal our business is, you may need a beefy WCR at the end of the year, and a leaner one for the first few months of winter. It all depends on your buying habits, what you buy, when you buy it, and where your business is located.

EARN OUTS: An “earn out” is used as a risk-allocation vehicle, where part of the purchase price of a company is deferred. The earn-out is paid based on your performance over a specific period of time, and it’s tied to metrics such as gross revenue, sales revenue, or EBITDA. Most of the M&A panelists don’t use earn outs when acquiring businesses. This is the case because earn outs are hard to control, especially when an acquired business is co-mingled with a larger enterprise.

The large enterprise might take over buying or payroll, and it’s difficult to see just who / what contributed to overall performance. Plus, the seller loses control of other aspects of his or her business, such as marketing and hiring of salespeople, further clouding the waters. Most buyers said they’d rather just pay cash at close, and that’s the end of the deal.

These were the top concerns of the dealers in the room and the panelists speaking to them at the LBM Strategies Conference. If you have other concerns that were not addressed, please contact me, and maybe we’ll put your question and answer in a future column.

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