I was interviewed by my friend Ted Leverette and shared my tips on reviving troubled buy-sell deals. Have a listen.
I was reminded of the Billy Crystal movie City Slickers when I saw the following, which would be funny if these people weren’t damaging our planet:
- A Seattle Times article on how the Cascade wilderness areas are being trashed (organic and inorganic waste) by city people deciding to get outdoors during the pandemic but not knowing how to act (as in, carry out their waste).
- A neighbor who loves the isolated outdoors said a deep-woods campground that usually has half of their 30 campsites available was filled with large RVs the last time he went there.
- A recent Wall Street Journal human interest article about city dwellers experiences in the outdoors. The two best stories are about the young lady who didn’t bring a sleeping bag because it was hot out, camped in a valley, and said she had never been so cold in her life and another lady who was appalled by campsite restrooms (an outhouse I’m assuming) and drove over a mile to a gas station to relieve herself.
So what does this have to do with business? The analogy is there are a lot of people who get into business with the same amount of preparation as the city slickers described above. I get calls regularly from people wanting to get into business (often starting one) and it’s usually to create a job using their skills versus growing a business (I refer these people to the local SBA/SCORE office so they can get a mentor and counseling).
- Know why you want to do what you’re going to do.
- Get the right help to succeed.
- Realize getting into business (or exiting) isn’t easy.
- Make a decision; analysis paralysis doesn’t help anybody.
Things always look better and easier from the outside. Just like, “the grass is always greener on the other side.” It’s only looks easy, better, or greener when you don’t do the things you’re supposed to do and do them correctly. Doing it the right way takes more time and effort, and it’s worth it.
“If You Don’t Have Time to Do It Right, When Will You Have Time to Do It Over” John Wooden
A business owner told me his sales were X dollars – put in whatever figure you want, $100,000, $1,000,000 or $10,000,000. His actual sales were:
- 2017 – 90% of X
- 2018 – 75% of X
- 2019 – 65% of X
- 2020 – on track for 50% of X
The abovementioned owner is coasting and the business is going downhill. And once on the slope it’s tough to recover. I’m sure there’s not a lot of calling to customers, much less prospective customers. I can’t imagine there’s much marketing at all.
What’s compounding this is he has no idea of what’s really going on. Yet all it takes is paying attention to the financial statements. He doesn’t need to have management reports, although they would add a lot of value and clarity.
Business buyers want one of two things:
- A well-oiled machine with room to grow.
- An underperforming business in a solid industry (coasting).
What they rarely want is a damaged beyond-repair business. Whether you’re an owner or advise owners, keep these points in mind. Coasting (downhill) doesn’t let you exit with style, grace, and more money.
“If liberty means anything at all it means the right to tell people what they do not what to hear.” George Orwell
For some interesting early summer reading here are a few things from my buy-sell world. Issues that, for the most part, can be avoided by asking the right questions. However, I can tell you from experience even if you ask the right questions you don’t always get the right answer (meaning what the client really thinks).
Question: (for all owners thinking of selling) “Have you worked with a financial professional to see if the proceeds from the sale are enough for your next great adventure in life?” A deal collapsed when the seller said because of other financial matters in his life he just can’t sell his business now. Believe me, this is not the first time I’ve experienced this, with both my clients and those on the other side of the deal. Plan before you jump.
Question: “What will you do when you sell your business?” I was working on a project involving selling the company to the management team. The owner, a client of at least three other projects, insisted he was prepared to sell. In reality, he wasn’t. He didn’t know what he would do, especially since the answer to the question was not, “Retirement.” He can’t see himself retired. Now, if the answer is retirement, my next question is, “Does your spouse want you around 24/7?”
Question: “Regarding your offer, can you show me your financing package?” A business buyer lost a deal to two other offers that were substantially higher than his offer. Then both other offers couldn’t get the financing together. My constant advise to buyers is, get financing alternatives lined up before making an offer. Another buyer got bank indications of interest before making the offer and it was powerful.
Question: “Have you hit past projections?” There’s a deal lingering because the company (actually the very optimistic seller) can’t seem to ever hit their projections. Another deal was lost recently because the seller insisted on a price based partially on earnings projections for 2019. When those projections turned out to be 25% above the actual earnings the buyer wondered if growth was possible.
Question: “What are your anticipated capital expenditures?” A business owner is touting the firm’s EBITDA as actual earnings. Yet 25-30% of annual EBITDA is new equipment with an immediate write-off. That’s cash out the door or bank payments over time. It’s a real expense. This is a lot different than when capital expenditures are for a handful of computers and are only 3% of EBITDA.
To summarize, ask the right questions (usually you’ll get an honest answer), realize how little projections are worth in today’s fast-moving world, get financing lined up before making an offer (on anything, business, home, commercial real estate, etc.), and realize while depreciation used to be a “non-cash” expense, these days it’s probably a real expense in the year assets were purchased.
“The solution to the mystery is always inferior to the mystery itself.” Jorge Luis Borges
From June 4-10 Jessica and I interviewed bankers representing eight Puget Sound area banks.* This memo is a synopsis of those conversations about what’s going on in banking during the COVID crisis, with a focus on business acquisition loans.
If you want the full report, click here to get it. It’s in table format so you can easily see what each banker said on the various topics.
First, all the banks are, “Open for business” meaning they are considering making loans. What’s changed is underwriting is going to take longer and will be more thorough (my comment – underwriting wasn’t sloppy before COVID, especially compared to the years leading up to the Great Recession). COVID will be a focus of all analysis and underwriting, where the business was pre-COVID, how it was affected, what the future looks like.
Year-to-date monthly statements are extremely important. The banks recognize there are a lot of unknowns and realize we all fear the unknown to varying degrees. Projections will be scrutinized more than ever and owners and buyers who can present thoughtful projections, answer questions realistically, and not gloss over the current situation will be in a more favorable position.
My accounting and CFO friends will like the following: the quality of the financial statements has never been more important. Some banks will look at the accounting department, ask if there’s a CFO or controller, and use that in their decision-making process. Having the owner’s sister-in-law who’s really a data-entry person but called the controller won’t cut it.
And, no surprise, there will be more sensitivity analyses and stress tests. Mentioned a few times was the figure “30%,” as in, what will the business, its cash flow, and debt coverage look like if revenue goes down 30%. As part of this, banks that previously did more conventional loans will now be looking to use the SBA 7A program (for its guarantees to the bank).
Consistently mentioned was how important relationship is (the PPP showed this) as well as how borrowers with known and quality advisors will be looked upon more favorably. It was said the source of the referral matters and if advisors are involved it’s a big plus. A few people encouraged borrowers to talk to multiple banks, find the right fit, talk holistically about how banking works, and have thoughtful questions and answers. Especially in regard to how the business is handling the COVID stress.
* Bankers who helped us
- Banner Bank – Lynell Smith & Jacque Coyan
- Columbia Bank – Jeff Wilcox
- Heritage Bank – Addie Roberge
- Key Bank – Jane Pekasky & Jennifer Ringenbach
- Live Oak Bank – Lisa Forrest
- NW Bank – Gary Strand
- Sound Credit Union – Donna Himpler
- WA Trust Bank – Kit Gerwels
A few months ago, the Wall Street Journal had an article on Boeing’s recent problems titled, “The Gang That Couldn’t Fly Straight. It covered how Boeing got so off track. I’m not qualified to analyze Boeing’s issues and the article made it seem they made some decisions based on numbers versus the planes or the people. It reminded me of when in “The Reckoning,” David Halberstam wrote about Lee Iacocca’s outrage because the financial people, who had such power at Ford, had “so little feel for cars.”
For many years there was an incredible demand of planes. Did Boeing lose their “feel for planes?” (and for people?). It was boom times for sure as it was for many other businesses. It caught up with Boeing and it’s catching up with other businesses. As I heard on a recent webinar, “Any company can do well in a boom.”
When things are easy there’s less attention paid to the details, especially the details about what a business buyer will want. Here are some examples of businesses I’ve seen in the last month or so.
- A proprietary product manufacturing company with an 82-year-old owner who is (still) the product designer, especially for the little tweaks each customer wants.
- A booming manufacturer with 90% of sales to one customer. The customer is no longer local and supposedly uses this firm because they can’t find a supplier near their current location. What happens when they do find a nearby supplier?
- A firm reduced to a skeleton staff due to COVID, their best month over the last three showed sales at about 30% of last year, and they want to sell for a large, guaranteed price.
- A very solid consumer business wanting to capitalize on a COVID spike in business, assuming (hoping) it’s a trend. Deeper analysis of sales shows it most likely is a spike.
Once again, it’s easy when things are booming. But business buyers want to know what happens when it’s not booming, when dependencies like the above owner and dominant customer manifest themselves, or what COVID and other risk factors do to the business.
And speaking of COVID and how it’s affecting buy-sell deals, here’s what my friend Gregory Kovsky with IBA wrote me, “…until a business shows three months in a row substantially similar to 2019 prior to believing it has returned to its prior strength and where historical valuation models are appropriate. Until that occurs, I believe some adjustment mechanism is warranted related to the ultimate value of a business in a transaction paid by the buyer to a seller.” For those of you not in the buy-sell industry, it means the buyer probably won’t guarantee the full price upfront, will pay a lower price, or a combination (or some other adjustment technique).
The value of a business is really what a buyer will pay for it. Too many risk factors and the price goes down. And the bottom line is, many of the risk factors present in small and mid-sized businesses can be mitigated over time. It takes awareness and effort. With COVID, we just don’t know.
“There seems to be some perverse human characteristic that likes to make easy things difficult.” Warren Buffett
I’ve been asked by quite a few people for my thoughts on business valuations and deals during the COVID-19 crisis. I’ve also been asked if there will be a lot of “good deals.” Here are my thoughts, the first one being extremely important.
There will be no “deals” on good businesses, i.e. ones that survived or thrived during the virus crisis.
My second thought is almost as important:
Nobody really knows what’s going to happen. If they say they do (know) watch out because the BS meter is in the red zone. We’re in unchartered territory.
Good businesses include many essential businesses, especially those whose customers are essential, whose suppliers are essential, and can show their performance is sustainable, i.e. not a temporary spike. For businesses like this please keep in mind, the seller will control the deal.
Where will there be “deals?” They’ll be on hurt businesses, which is the only time a buyer will control the deal. But who wants a hurt business? One with long-term damage? In my opinion, it will most likely be another company in the same or similar space. A company that can absorb overhead, create synergies, wants good employees, etc. Maybe even a job for the seller. And this is where the buyer can control the deal. Most financial buyers won’t want a hurt company.
Before I get into valuation, here are some other things I expect we’ll see:
- More seller financing, in fact banks are already indicating they want more seller financing.
- More buyer cash at closing, banks will shy away from the 10% down from the buyer (SBA loans) and want it at least 15-20% if not more.
- For businesses successful during the virus crisis, an emphasis of analysis will be on: is it a spike or a trend; who’s creating the increased sales; what product mix is being bought; what type of customers, etc.?
- Expect business sellers to take longer than buyers and banks and CPAs to adjust to the new norm of deals, including that more patience will be needed as deals will take longer to close. Us intermediaries will adjust pretty fast; we’re seeing firsthand what’s going on in the market.
- More emphasis on current financial statements, meaning monthly statements with comparisons to the previous year.
- Buyers, banks, and intermediaries wanting to see a number of months back to normal or on the right track before committing.
- More COVID related due diligence (some banks have COVID questionnaires), more attention to intangibles, detailed diligence on any PPP funding; and industry experience will be a big plus for buyers.
- Banks will be running more and tougher stress tests on all loans (meaning, looking at more scenarios of debt coverage if sales and earnings decline).
- More earnouts, i.e. part of the price based on performance. Or, claw backs, which are a negative earnout if future numbers are not hit and which is how any variable pricing has to be handled for an SBA loan.
I started with statements about deals and forecasting. My third statement is about valuation:
It will be trickier than ever to value many businesses.
I’m regularly asked, “What’s the multiple for this business?” or someone will say, “I’d pay X times EBITDA for that company.” As I like to say, there is no set multiple for any business or industry. There’s a typical range (different ranges for micro, small, mid-sized, lower middle market, etc.) and where in that range a business’s value falls has to deal with the risk and reward factors, i.e. the non-financial factors, such as:
- Customer concentration or diversity
- Dependency on the owner or key employee
- Growth potential
- Barriers to entry
- Competitive advantage
In 2020 we have to add:
- Government intervention (for example, essential or non-essential)
- Safety of employees and its cost
- Very recent history (months not years)
- The COVID affect, short, medium, and long term
- Customer demand for companies where in-person activity is required or suppliers to those firms – think airlines plus their effect on Boeing, Boeing suppliers, hospitality, recreation, etc.
In other words, there are a lot of unknowns. Historically, the first set of risk and reward factors above are known, or pretty much known. The second set are ambiguous and even the recent financial statements will need to have an analysis to see if recent performance is sustainable or a “V-shaped downturn and recovery” or a “long-term trough.” An appraiser will be a bit more analytical with these new factors than a buyer (or seller) will be. Buyers will rely more on gut feel when it comes to the price they’ll pay, and how they’ll pay it (which is different than the value an appraiser comes up with). The seller’s gut will still tell them their business is the greatest thing since cold beer, sliced bread, or whatever cliché you want to use. Bankers will be digging deeper than ever because, and this is obvious, they want to get paid back.
Appraisers use historical financial information and cashflow projections. If it was me, I’d be very cautious using projections and if I did, I’d want to see the projections the company had in their 2020 budget. I recently saw a valuation with a 10-year projection of revenue and profits. Ten years? It’s hard to project 10 months. Heck, it’s hard to project even 10 weeks. Based on surveys I’ve seen, about 75% of small to lower middle market firms have seen a sales decline this year. In other words, smart people will be comparing a company’s projections to their past projections and performance.
There is no one size fits all answer. If the business has stayed on course or showed sustainable growth the value will increase, and the price paid will probably increase even more. If the business has suffered, watch out, the value will be a lot lower, buyers will be skittish, and even more skeptical than ever. For those in the middle, not growing but not suffering, maybe having slightly lower earnings, it’s going to be “beauty is in the eye of the beholder.” The same ranges of value will hold true with more companies on the lower end with earnouts allowing them to climb higher in that range. I wish there was a more clear-cut answer.
On May 12, 2020 GeekWire reported Seattle company Porch is being sued by Kandela, a company Porch acquired in April 2019. The basis of the lawsuit is Porch did all they could to stunt Kandela’s growth and profitability in order to avoid paying an earnout. If you’re not familiar with an earnout, it’s similar to a salesperson’s commission in that payment is based on performance.
The Porch lawsuit alleges they (and this is from GeekWire), “have engaged in a stunning and systematic pattern of fraud designed to prevent Kandela from achieving any earnout” for hitting certain milestones, according to the complaint. They went on to say Porch withheld resources, refused to sell Kandela products (to Porch’s customers), and more.
It’s why lawyers will joke and say the only winners with an earnout are the litigators. That said, in our pandemic world, everybody I’ve heard from believes earnouts will be more prevalent. And as much as I don’t like them, other than for special circumstances, I agree with this and have a business buyer client making an offer with a significant earnout component as the business has been hurt by the pandemic, and nobody knows how fast it will come back or at what level.
My advice to my client was:
- Keep it simple.
- Make sure the seller can easily get to and see how he can get his full price.
- Emphasize your goal to make the recovery as fast as possible (it’s in the buyer’s best interest anyway).
There are a lot of people out there who think there will be “deals” on business acquisitions. There will be on damaged companies (a deal meaning a lower price albeit for a company with less profit), there won’t be on solid companies, and earnouts will play a part in more deals than before (as will more seller financing). The objective is to have it be fair to both sides and be easy to figure out.
“Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.” Will Rogers
Over the last four years we’ve tracked every incoming referral. We note the date, source, and type (business buyer, seller, exit planning, etc.). There’s no pattern, that’s for sure. But there’s been growth and consistency within a tight range.
That is until mid-February of this year when, guess what, a certain virus started making headlines. Over the next 10 weeks we got a total of two referrals. Then, six in 10 days.
- There’s pent-up demand to get going again.
- Maybe (former Presidential candidate) Andrew Yang is right when he says companies have been looking to shed workers (before the pandemic) and won’t be rehiring them. They’ll run leaner.
- I wonder if managers and executives are sensing this and starting to think about controlling their career destiny via business ownership.
Speaking of business ownership, there are only three ways to get into business. You can start one, invest in a franchise, or buy an existing company. Preferably a mature, profitable, and fairly priced company (disclaimer: this is where I come in, helping people buy the right business the right way).
Buying the right business the right way means separating yourself from the bottom-feeders that have come out. I’ve talked to numerous owners in pandemic-distressed industries (and to other advisors). They tell me the bottom feeders will say things like, “We’ll get you out of your business by purchasing your customer list,” or, “We’ll buy your (tangible) assets.” No mention of what happens to the seller’s lease, equipment payments, etc.
“There’s gold in them thar hills” (Mark Twain, The American Claimant, 1892). Unfortunately, some businesses won’t make it and this means opportunity for others. There will be openings for acquisitions (second disclaimer: I wrote a book titled, Company Growth By Acquisition Makes Dollars & Sense). And I mean fair acquisitions to bail out a bad situation, and maybe even a job for the seller.
A crisis like we’re going through brings out the best and the worst in people. Be part of the best, not like the bottom feeders.
“A ship in a harbor is safe, but that’s not what ships are for.” (Author) John A. Shedd
Like a lot of you I’ve been on more webinars the last six weeks than I usually go on in six months to a year. And, there’s actually been some good ones.
An interesting one was put on by Salesforce and featured Mark Cuban. A few of the things he said were:
- Now is the time to amplify your brand.
- Connect with people, don’t sell.
- Everybody is scared (at some varying level).
- The disaster recovery programs from the government are like automatic overdraft protection.
A really good webinar was put on by Business Brokerage Press (BBP) and the points the experts made are valuable for more than just the buy-sell industry. Here are the ones I noted with my comments in parentheses:
- We all need to do a better job of screening potential clients and customers to make sure they’re serious, what they have is viable, they’re viable. (Not just now, always.)
- Most owners are concentrating on core business functions, not exit planning. (Many are concentrating on survival.)
- For new clients, now is the time to get paperwork in order and be ready to go when the time is right.
- Baby boomers are not getting any younger. The tsunami of exiting owners predicted over the last 10-12 years hasn’t hit yet. Maybe this will push it over the top. (I agree, there’s been no spike of exiting owners, just a slow increase.)
- To business sellers, set a firm expectation of value and cash at closing. (They emphasized the word firm as we know people remember what they want to remember.)
- To owners who have been coasting – watch out! (Yes, a culture of coasting will be hard to change to one of urgency.)
- Good people will be available to improve your team. (On my Zoom Happy Hour on April 16 Joe Fugere said they’re looking at all the good people let go by other restaurants.)
- Show you can bounce back. (Not just for those selling but for those wanting to reassure customers, employees, and vendors).
- Business buyers will be expecting deals and consider using an earnout.
- This will push up bottom feeder (business buyers) and it’s way too soon to get freaked out over value. (I agree, I’m seeing the bottom feeders out there, going after businesses in industries hit hard.)
- Business buyers who want to pay based on the last 12 months of earnings for businesses hurt by COVID-19 won’t want to pay based on the last 12 months for those companies that got a spike.
- The reverse is true of sellers.
- Buy-sell experts are going to have to figure out how to mitigate the situation. We could see deal structures change (more seller financing), more earnouts, buyers will be more cautious, etc. (And, we don’t know how banks are going to look at all of this.)
On the other end of the spectrum, I was on a Zoom meeting with a bunch of corporate people and corporate consultants. Talk about heads in the ozone. These people had no idea about the “real world.” One lady actually said that nobody will want to own a car anymore now that we know we can all work from home. Okay, other than those people delivering things to her home, working in stores, on construction sites, installing furnaces, cutting hair, etc. Or, those who like the freedom of getting out, hauling their boat, going skiing, and other activities.
Regarding the points from BBP, I can’t argue with the points made and I also think you can take out the business buy-sell specifics and apply most of these points to business in general. Businesses shouldn’t coast, we don’t know what banks will do regarding lines of credit and other non-transaction loans, and many of us will have to mitigate numerous circumstances.