As Featured in LBM Journal
Selling a business is a lot like selling a home. You benefit by taking advantage of the equity built over the years. But there are potential pitfalls when selling a business, especially if this is new to you. The world of mergers and acquisitions is very specialized and it requires experience to successfully navigate and to maximize your business value for strategic and financial acquirers.
As you prepare to stage a business for sale, note that you may have multiple reasons to sell your company (liquidity, retirement, family buyouts), but acquirers will be less sentimental. They purchase businesses because A) they're profitable, B) they are strategically important, and C) the businesses can eventually be sold for higher value.
Acquirers gauge the value of your business largely through earnings. But the quality of earnings can vary, and sophisticated buyers will reward (or discount) accordingly. With your EBITDA, you can calculate the worth of your business because businesses are valued as a “multiple of EBITDA,” and earnings are the gold standard for determining what acquirers will pay. That way an acquirer is assured that he is not buying a $50 million company that is on the verge of bankruptcy. (EBITDA is net income, plus interest expense, plus taxes, plus depreciation and amortization.)
"Sophisticated buyers will reward or discount accordingly."
Earnings are affected by business operations in three categories: financial, nonfinancial, and risk.
A Well-run business: Acquirers will look at your growth rates, business resilience, margins, and balance sheet. Acquirers will also look to see if your customers are overly concentrated. (You don’t want any one customer representing 10+% of sales). Acquirers will also look at the quality of your A/R. Do you have a clean balance sheet with disciplined collections? Is the majority of your receivables collected in under 30-days? Those are key indicators of a well-run business.
Nonfinancial: Acquirers will look at location, products you carry or control, your company culture and brand, your leadership continuity, and your workforce talent (especially sales).
Risks: Acquirers will want to know about any legal issues (lawsuits, settlements, contracts), regulatory compliance risks (site concerns), credit risks, safety risks, and personnel benefits/pension exposure. Eliminating or containing risks is essential for attaining the highest value.
What value multiples are used today?
What value multiples are used today? Citing recent data from 308 transactions, spanning Q1 2014 to Q2 2015 in the LBM sector, the multiples of EBITDA paid averaged from 6.4 to 7.1 with individual transactions significantly higher and lower than those averages. For a $10 million EBITDA company, the value changes from a low of $64 million to a high of $71 million. (It’s not uncommon for a $7 million value gap like that to be closed simply by implementing best practices on A/R or margins that boost the multiple used to calculate value.)
Let's look at some hypothetical companies with the same earnings that are acquired at different multiples. Assume Companies A, B, and C all have $15 million in revenues, and all three have $1.2 million EBITDA. Company A sells for $3.6 million (3X multiple). Company B sells for $7.2 million (6X) and Company C sells for $9.6 million (8X). Why the different values? The acquirer rewarded (or discounted) because the quality of the following items varied beyond expected baselines:
- The quality of the A/R
It’s absolutely key to have collection and credit controlled; acquirers will discount for dated A/R.
- The quality of the P&L:
Are earnings consistently growing year-on-year? Showing a consistent compound annual rate of growth (CARG) is key.
- The business growth rate and resilience
How did you do in 2008 and since? Acquirers will look closely at details.
- Customer concentration of sales:
No more than 10% of your business with one customer.
Are margins within industry benchmarks? If not, why?
Are they non-existent, or contained?
If an acquirer finds problems with one or more of these items, the multiple of value could turn down to 1X, 2X, 3X or more. Work through this list with an M&A advisor, starting with the quality of your A/R and finishing with eliminating risks. The rewards for a little preparation and good advice are enormous.