Probably like everyone in XPX, while in conversation with other professionals, I’m commonly asked “Who’s your biggest competitor?”  I usually respond: “Inertia!” I know that may sound like a flippant joke, so I politely pivot and give kudos to the other good practitioners in the ESOP advisory business and say they are more friends than competitors.  However, my first answer wasn’t really a joke.  Inertia most often is the biggest competitor to us advising on business transition.  Despite the obvious inevitability, doing nothing or putting off planning for transition is by far the most likely decision owners make regarding our advice.  Patience and persistence seems to be the only response.  Inevitably, the business will transition, and inertia will lose the competition.

Any thoughts from the peanut gallery on how to overcome inertia? 

All business owners want growth. For some lucky businesses – those with new technologies or trendy products--growth seems to “just happen”, at least for a while. In most cases, however, owners try every trick in the book to get more revenue, often with erratic and even frustrating results. The truth is, despite owners desiring it, most businesses are not ready for growth. Company systems and process have either not been designed, built, or updated for growth. And many businesses experiencing rapid “lucky” growth don’t have the corporate infrastructure to support it for the longterm. Click here to continue reading....

As we venture into 2019 it’s important as a business owner to understand the value of your business. Agreeing on your company's value will make or break a transaction - ultimately, a company is only worth what someone else is willing to pay for it. There are four key elements that impact every valuation:

• The Buyer
• Cash Flow
• Risk
• You

The Buyer

When corporations buy small businesses they usually achieve economies of scale. They can realize stronger margins by controlling wholesale purchasing decisions, streamlining back office functions, expanding market share, or a number of other methods. As a result, they create enough value to their own enterprise to break even on the investment in 3-5 years.

Don't go into the deal assuming that the corporate buyer pays more because "they have deep pockets".  If you expect to hold them up, you'll be the one left holding the bag.  Instead, take some time to understand how their valuation criteria differ from individuals.  This will help you better understand how to align your objectives with those of your potential buyers, and may help you to gain a better understanding of the differences between the buyer who will pay the most and the buyer who you may prefer to sell to.

Cash Flow

Cash is king, and at the end of each year after all expenses are paid, there is only so much left over - and buyers require a minimum return on their investment.  Therefore, cash flow dictates value more than any other component.  Your business needs to generate enough cash to cover all operating expenses, any debt required to complete the transaction and a return for the buyer.  If cash flow cannot cover all three (at the price for which you expect to sell), then your pricing expectations are not aligned with your company's profitability. Even those of you that value businesses based on multiples of EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization, a common measure of profitability). For example "3 X EBITDA” cash flow still weighs heavily on the valuation. If you're not profitable and you don't meet other criteria, you are likely to be valued at less than "3 X EBITDA".  Furthermore, the buyer type is critical here.  "3 X EBITDA", or any revenue multiple, is only relevant for corporate/strategic buyers who are attempting to consolidate an industry and capitalize on economies of scale.  For those of you targeting individual buyers or private equity buyers, cash flow drives the valuation and revenue multiples are irrelevant. 

Risk

What makes two otherwise identical companies worth very different amounts? In a word, risk.  Risk comes in all forms: the risk of losing key employees, customers, suppliers, or referral sources; the risk of an economic downturn or emergence of a disruptive technology; financial and legal risk; the risk of a departing owner.  Some of these are out of your control and apply to all businesses; others, however, are directly under your control.

 Consider two companies with $10 million in revenue and $1,000,000 in EBITDA. The first has a very diverse customer and supplier mix; all key employees have been with the business for years, have signed non-competes, and perform at or above industry benchmarks for their position; and, the owner is not active in the daily operations.  The second relies primarily on two large customers  and the owner generates over half of the revenue.  Assuming the industry and market sizes are the same, the first company will capture a much stronger valuation due to the absence of many key risk factors.

You

As the owner and seller of the company, your actions and decisions can impact the transaction value significantly. If you are a key contributor to the business and therefore difficult to replace, the buyer has a key problem to solve - how do they maintain current sales volumes and cash flow when you leave?  You can choose to be a part of the solution, helping to facilitate a transition and/or agree to continued employment after the sale closes; by doing this, you help preserve value for the buyer, and as a result can achieve a stronger valuation.  If, however, you decide to be a part of the problem and ignore the issue (or refuse to help), then you can expect your valuation to take a hit (and certain buyers to walk away altogether).

 Owners can also scare off buyers or negatively impact value by their actions during the sale process.  They can do this in many ways, with the three most common being window shopping, making unrealistic demands, and failing to present the business properly.

If you enter into the sale process without being 100% committed to selling, soliciting offers with no real intention of closing a transaction unless someone overpays for your business, then you run the risk of annoying and possibly offending buyers.  This is especially true in a consolidating industry, in which there is a limited pool of buyers offering strong valuations.  These buyers will stop taking you seriously, and when you finally decide to commit to selling they will remember their previous interactions with you and value the business accordingly (e.g. very conservatively and reluctant to make a fully valued offer).

Conclusion

Numbers don't lie, and nothing can improve your company's value as much as revenue growth and strong margins.  That aside, since valuations are always expressed as ranges it is important to understand why companies skew to certain ends of the range.  Many of the differences between companies that achieve strong valuations and those on the lower end of the scale are factors under the owner's control.  While you may not be able to control which buyers will be interested in the future, you can control your behaviors and actions and many of the key risk factors that impact valuations.  Focus on these to drive the necessary change, and you will be rewarded with a stronger valuation when you make your exit.

XPX Chicago member, Jim Junker, MD of Pilot Hill Advisors is excited to announce the completion of another successful deal in the Midwest!  Two owners of a Michigan IT services firm recently sold the company via a 100% leveraged ESOP, putting the company and the employees in a position to thrive.  The two owners had been partners in the 20 year “overnight success” since founding the firm.  One owner was of retirement age and was able to largely step away and leave the management to his younger partner as CEO.  The CEO is excited about managing a company with engaged employees and effectively no state or federal income tax burden.  Both owners were able to realize a fair sale price comparable to a sale to a third party financial buyer.  Most importantly to them, the legacy of their firm is intact and the managers and employees have the opportunity to enjoy the benefit of the bright future of the firm.  Pilot Hill Advisors is proud to have quarterbacked this transaction for this important American company!  

XPX MEMBER SPOTLIGHT: PETER HOLTON

Business owners have put blood, sweat and tears into building their businesses. Most have created a detailed plan, a vision of what they hope to accomplish while owning a company. All good things must come to an end and at some point it’s time for the next chapter of life to begin. Have you thought about your exit plan? In order to maximize the value of your business in a sale it is important to understand what I call the “5K’s”.

Know what your business is worth in the marketplace

Typically the largest asset owned by a business owner is their business. Many people ask me “How much is my business worth? What multiple should I sell my business at?” There is no simple formula or quick answer. Each business is unique and back of the envelope math is rarely accurate. The only way to know what your business is worth is to invest the resources into a comprehensive business valuation that will analyze your business internally as well as compare it to other comparable businesses that have recently been sold.  

Know what motivates buyers

There are three primary types of buyers: large companies, private equity groups, and private individuals. Each buyer has their own strategic objectives and a unique perception of value. It is extremely important to know how to present your business in a way that will align with a buyer’s motivations. Understanding the buyer’s perspectives can help you negotiate a better deal.

Know when to sell

I find it funny that when a professional athlete is in a contract year they typically end up having the best year of their career. They go into free agency and find a team willing to overpay on their next contract. Using the same analogy, if your business is thriving then now is the time to sell it in order to maximize value. There are three factors to consider when selling your business: personal timing, company timing and market timing. The natural tendency is to base your decision on personal timing – e.g. when you want to retire or when you are forced to sell due to illness, divorce, etc. I cannot stress enough – personal timing is the least important factor. Buyers do not care that you want to retire, but they do care if your business is growing; likewise, the market won’t be hot just because you want to sell, but you can choose to sell when the market timing is right. John Elway and Ray Lewis each retired the year following Super Bowl victories. They could have played another season, but each knew they had the opportunity to go out on top and did just that.

Know the difference between Price VS Terms

The obvious goal of every business owner is to sell their company for maximum value. Unfortunately, too many owners only focus on the price without giving proper consideration to the terms of the deal. This can lead to disappointing and even disastrous results. Consider two offers for the same business, one for $10M, paid all in cash at closing, and the second for $13M, paid out over 10 years. Without understanding the terms, there appears to be a significant gap between the two; however, depending on how the $13M deal is structured, the seller may not collect the full $13M and may end up worse than if they had accepted the “lower” offer. At the end of the day there are many ways to structure a deal for both parties. The more flexible you are as a seller, the more likely you will reach a positive outcome.

Know how to manage the deal process

It is imperative to know and understand the steps in the deal process. Every deal is different, but on average it takes roughly 6 to 12 months to sell a business. There are four keys to the deal process: preparation, marketing, deal structuring, and closing. We all know that practice and preparation are the key ingredients to win in sports, the same applies to a successful sale of your business. If the preparation is done correctly all other portions of the deal process will flow smoothly.

Having a third party to help you prepare your business for sale and represent YOU with no emotional connection to your business can boost your retirement income. Let’s face it; if you’re like most people you are counting on your business to fund your retirement. At the end of the day, selling a business is a lot like lawn care. Everybody knows how to do it to a certain degree, but only a select few truly excel and produce astonishing results.

It was a great meeting! Here's the video: 

XPX MEMBER SPOTLIGHT: PETER HOLTON

XPX Chicago member, Peter Holton, the Managing Director of Caber Hill Advisors announced today that it advised a Midwest janitorial company in the sale of their business to Anchor Building Services of Chicago, IL.

“The reputation and history of the seller was the main attraction for me in our partnership with the company. The owner and his family have built a wonderful business over the years and we are excited to continue the legacy going forward. The accounts the company has worked with over the years provides an avenue to continue to grow Anchor Building Services and to become of the most dominate players in the Chicago market, “said Tom Prybylo Jr., President of Anchor Building Services.

“Of the different possible buyers, I feel Peter Holton brought us the right fit for our multi-generational company. Tom, and his team at Anchor, are committed to allowing our operations staff to continue serving our clients, which provided me the comfort I needed to entrust him with our company, clients and employees. It's a great way to move into retirement “said the seller of the Midwest based janitorial company.

“I thought I understood what was involved in offering my company for sale but was not prepared for the roller coaster ride of the preparation and process. Peter Holton and the entire Caber Hill Advisors team were a huge help in getting us ready for the sale process and guiding us through to a successful sale. During the process, Peter was invaluable in keeping me at ease, “said the Seller.

The process was led by Peter J. Holton, Managing Director of Caber Hill Advisors, who leads the firm’s efforts nationally in the janitorial industry. For more information, please email him at peter@caberhill.com.

About Caber Hill Advisors

Caber Hill Advisors is committed to working with business owners so they can successfully fulfill their personal and professional legacies. We serve small and middle market companies, in very specific verticals, who want to either sell their business or make an acquisition. Our firm's innovative approach combines the best elements of the local business brokerage community and the large, very expensive investment banks.

The result is that our clients receive individualized attention and expert guidance specific to their industries. Our professionals have all worked in the markets we now serve, and while each individual has a strong track record of successful transactions, we're not just "deal guys". In fact, each of us has either owned a business, grown up in a family business, or personally invested in small companies. This gives us a deeper understanding of the challenges facing business owners and allows us to focus on more than just closing the deal.

At XPX Chicago, we are a community of professional advisors who work collaboratively to help U.S. privately-held businesses build long-term, sustainable and realizable value. Share your success stories with fellow XPX members by e-mailing them to Laura Yunger, CEO of Saltare Solutions and XPX Chicago Communications Chair: lyunger@saltaresolutions.com

XPX MEMBER SPOTLIGHT: CHRIS MANICK

XPX Chicago member Christopher Manick, M&A/SBA Specialist with Busey Bank, recently transitioned a 30-year-old niche manufacturing company in the Chicagoland Area. The transition in ownership occurred between the seller and the company’s Shop Supervisor/Manager, who had been with the company for over 20 years. 

The sale and transition of the business was not easy or quick. After several years of the broker trying to attract strategic buyers, the broker refocused efforts on selling the business internally to the Shop Supervisor/Manager – who had the technical knowledge and experience to continue to run and grow the business.

The seller and buyer of the transaction faced a number of challenges with several failed attempts to secure bank financing. Once the transaction was presented to Busey Bank, the deal was structured with a $5 Million SBA 7a Loan that financed the purchase of the company’s commercial real estate, highly specialized heavy equipment and a significant amount of goodwill.

This transaction left in its wake:

• A multimillion dollar payout for the seller that secured his family’s retirement
• Secure jobs/careers for 20 employees, most of whom had been with the company for 10-20 years
• Referrals made from the Deal Team:
• • M&A Attorney
  • Wealth Management Advisor
  • PEO Firm

At XPX Chicago, we are a community of professional advisors who work collaboratively to help U.S. privately-held businesses build long-term, sustainable and realizable value. Share your success stories with fellow XPX members by e-mailing them to Laura Yunger, CEO of Saltare Solutions and XPX Chicago Communications Chair: lyunger@saltaresolutions.com

It seemed very logical that the run up in equities in late 2017 in anticipation of lower corporate tax rates would significantly raise the value of privately held firms and ESOPs. The basic math of valuation dictates that higher free cash flows equals higher values. A no-brainer. However, we're starting to see data and anecdotal evidence that maybe valuations have remained more stable than we thought.

The drop in the top federal corporate tax rate from 35% to 21% was seen as exerting upward pressure on values as investor get to keep more of the cash flow. The stock market sure reacted in late 2017 with a big run up widely attributed to tax reform. Although many ESOP-owned companies pay reduced or zero effective tax rates, valuations of these companies are done on a tax paying C-Corp basis. Lower tax rates mean more free cash flow which increases the values. Early this year, ESOP appraisal firms gave indications of year-end valuation increases of 15% or more based solely on the lower tax rates, but cautioned that other factors such as growth rates and interest rates would be impacted by tax reform.

While there is no index of valuations, my conversations with appraisal firms indicate YOY increases in the 8-12% range for most ESOP companies based on the EOY 2017 valuations. The more modest increases are due to a combination of projected higher interest rates, slightly lower growth assumptions and the cap on interest deductions to 30% of EBITDA.

EBITDA multiples on public companies began a significant increase in late 2017 based on expectations of the lower tax rates and values on private companies are following. The EBITDA multiples increased from about 9.5x to 10.3X as tax reform became a reality. Early this year, we all assumed that prices paid for private companies by PE firms would follow the price increase of public companies. Interestingly, in Q1 2018, EBITDA multiples in middle market buyouts don't show that bump . According to GF Data, multiples for $10-250MM deals returned to about 6.9x after spiking to 8.0x in Q4 2017. 6.9x is consistent with 2017 averages. First quarter data is notoriously fickle and quarter to quarter variances can be wide, so it is a bit early to call a trend based on Q1 2018. However, I would not be surprised if valuations for private middle-market companies proved more resistant to increases than originally expected.

There may be a bit of a governor on deal valuations driven by a few factors. Private equity (PE) is the primary market maker in setting prices. PE buyouts usually rely on debt financing for a majority of the capital. I think it is likely that a combination of availability of debt capital and the new limitations on deductibility of interest is tending to cap how high EBITDA multiples can go. Due to regulatory pressures (and common sense) banks are loathe to exceed 2.5-3.0x in senior debt and 4.5-5.0x in total debt. The junior lenders may also have a ceiling around 5x either due to leverage or coverage limitations. Prices and leverage were already at very high levels in 2017 and any increase in purchase multiples would need to be 100% equity financed, driving down returns. Couple that with the limits on interest deductions to 30% of EBITDA and you could see an offsetting downward pressure that could keep multiples in check (although at a relatively high level).

We'll keep an eye on how this plays out as 2018 progresses. Should be interesting.

See the full blog here

XPX Chicago Members & guests enjoy a social get-together after work to start off the weekend with food and cocktails at Flagg Creek Golf Course in Countryside, Illinois.