It's Time to Buy. Or Sell.

Reprinted from SEMA News magazine, November 2004

by Jon Hedges

There's a lot of buying and selling going on.

Many in the aftermarket industry have called the first 10 years of this new century the “Decade of Consolidation.” It's been building for years as this crazy industry, and some of the participants, slowly mature.

Consolidation is a natural phase in any industry's life cycle as it matures—but don't get me wrong, this industry is a long way from slowing down (hey—there's a good reason to buy a business right there!).

A quick look back at recent years shows a lot of SEMA-member companies have changed hands. There have been some good deals in recent years, and some bad ones. There have been a lot of small companies bought and sold, as well as billion-dollar publicly traded corporations. In fact, according to some investors, 2004 has been the busiest year for mergers and acquisitions (M&A) in a long time.

Are you on the buy side or the sell side? If you're up for the challenge, here are some things to look for.

If You're Thinking of Selling

Sooner or later most business owners get to the point where they want to sell their business. This end game may have been part of an owner's plan all along. It may just be reality sinking in that an owner, now maybe 60 or 70 years old, needs to sell for various reasons. The owner may not have family to pass the business on to. Perhaps the owner died and the family now faces a big tax bill. Maybe the company needs additional investment to grow.

Sometimes internal family squabbles create the need to sell a business. This situation doesn't have to devalue the business. In fact there are people such as Stu Van Wagenen of Stuart Chase Properties in Cleveland that specialize in interim management of family-owned businesses in the middle of a dispute, often positioning for an eventual sale of the company.

Whatever the reason, this will be one of the biggest and most agonizing decisions an owner will ever make.

Most businesses in the aftermarket were started by an enthusiast who also was an entrepreneur. Many entrepreneurial businesses tend to lack formal business plans. If this is you, making your business an attractive target for a buyer now requires some organizing and planning.

So, the question is, what's your business worth, and how do you maximize its value?

One of the biggest complaints from potential investors trying to buy a business from an entrepreneurial owner is that they think the owner's unrealistic on the value. And you can hardly blame an owner after working 80-hour weeks, giving up vacations, bonding emotionally to the business, and dreaming big like most entrepreneurs.

One general rule of thumb is that investors will value a business at around five to seven times its current annual EBITDA—Earnings Before Interest, Taxes, Depreciation and Amortization—but there are reasons that companies sell for much less than this, or for significantly more. This ratio is called the “multiple.” Another way a business can be valued is a multiple of actual cash flow.

Bottom line: most buyers want to know the cash being generated by a business. Valuing a business on a multiple allows buyers to make a wise investment of their money, and lets bankers and investors (necessary partners in buying a business) sleep at night. Unprofitable or “distressed” businesses are valued on other things, and we won't cover those types of transactions here.

There is a big spread between five times or less, and seven times or more, EBITDA. Where you fall on that scale depends on the size and shape of your business, and the buyer.

It helps to be large. A larger company can sell for a higher multiple than a smaller company with the same profit percentage. Smaller companies for sale aren't as “visible,” either.

Prospective buyers like businesses that have a clean set of books. They usually look for some other characteristics, and the good news is these characteristics also make your business more valuable. They can include large market share, steady sales growth, a strong management team, strong brand recognition, a market segment with barriers to entry for competitors, proprietary technology, or a strong customer base with sales spread across a lot of customers.

If you have plans to sell, you'll maximize the value of your business if you have these characteristics in place. If they aren't in place and you might be selling your business in the next few years, now's the time to get started.

How much a buyer is willing to pay depends on the type of buyer. Buyers can usually be classified by motive—financial or strategic, or by function—an operator or an investor.

A buyer with a financial motive is one looking to make a profit on an investment by selling again, probably within three to seven years. A large financial buyer can afford to pay more than a small financial buyer for a desirable business.

A strategically motivated buyer is looking to make an acquisition for an existing business, and these buyers will tend to pay more for your business.

An operator buyer is one that wants to run a business, and may not be afraid of a turnaround or weak management, so an operator may be looking for lower valued businesses.

Businesses up to around $10 million in sales usually sell through business brokers, and businesses in the $7 million to $20 million range often use smaller “boutique” investment bankers. Larger businesses sell through larger investment bankers or directly to private equity buyers.

If You're Thinking of Buying

Buyers come in all sizes and shapes. They could be current business owners looking for a strategic acquisition or a semi-retired executive looking for something productive to do. They could be private equity firms, from a small one with a couple of million dollars in cash and good investment banking connections, up to firms with large multimillion-dollar funds backed by institutional investors.

Larger private equity companies invest a lot of time scouring the market for acquisitions. In fact, if you're a business owner with sales over $10 million you probably already get inquiry letters or phone calls from time to time.

It's a jungle out there. Jim Naylor of Teton Capital Group in Cleveland tells me there are now over 300 private equity firms across the country, each with more than $100 million in available funding, competing for acquisitions that make around $5 million EBITDA per year. There are many more hundreds of firms looking for smaller acquisitions.

The most time-intensive part of the buying side is finding the right business. It isn't unusual for private equity firms looking for the right investment to filter through 150 to 300 businesses before making one acquisition. For an individual investor with limited resources, finding the right business is harder.

One strategy for a buyer looking for a business with $5 million to $20 million is sales is to work with business broker, or a “boutique” investment banker that specializes in smaller deals. Brokers can do the initial screening for companies based on a buyer's criteria and charge a fee, usually commission-based.

Buyers can sometimes create mild panic, too, when a business owner is first contacted but wants to keep any rumors of selling the business from the employees. Sometimes contacting an owner through a friend or other connection is the best way to get through.

A business acquiring another business is taking on a big risk. Bankers or accountants stop most acquisitions that don't make sense financially, so most problems end up being strategic or with integration. Ask the tough questions: Are you buying more customers, and could you get them in other ways? Are you buying proprietary technology, or is it cheaper to outsource it in other ways? Are you buying a business to get into a different market, and are there better ways to get into that market? Should you even be in that market?

Conclusion

Buying or selling a business is a long, drawn-out process that can be emotionally charged. It's also more and more common as our industry goes through a wave of consolidation.

If you're a business owner that wants to maximize your payout, you need to plan for the sale by paying attention to the things important to investors. If you're looking to buy a business, have a plan, patience to sift through a lot of opportunities and a well thought out strategy.