Are You Lying to Me?

Next week I’ll get back to my review if the Boyd Group’s financial statements. But I wanted to discuss something that has been on my mind lately.

I’ll be travelling quite a bit in the coming weeks so if you are in the area shoot me an email and let’s meet up! This Saturday May 14th I’ll be hosting training session in conjunction with Automechanika near Ann Arbor, Michigan. I’ll be in St. Louis next week to present at the Refinish Distributors Alliance annual meeting. Then I’ll be in Barcelona, Spain presenting at the IBIS Global Summit.

One of my favorite aspects of my job is that I get to talk to a lot of business owners. I grew up in the collision industry and worked for a family business for a number of years so I have a real passion for helping business owners create real value in their business. For me, I feel like I still work with my family – just nationwide!

But in addition to working in the industry, I also have an MBA with a specialization in finance, and experience working in equity research, investment banking, and strategic advisory. So I have a very unique perspective on the industry. Perhaps the best way to sum it up is to repeat what a fellow shop owner said to me recently – “Dude, you can talk about finance and capital markets and in the next breath we can be talking about p-pages, repair methodology, and shop layout. It’s crazy!”

Because of this unique perspective, I often hear comments and assumptions made that make me cringe. At best, these comments can cause real harm if left unaddressed, and at worst can be used by savvy buyers to mislead a seller. These are the 5 most common misconceptions I hear when talking with clients considering a sale.

  1. I did $6 million in sales last year, so that means I’m worth at least $5.5 million. Oh, and I have a 5 week backlog.

The value of a business is based upon cash flow. Not sales and certainly not backlogs. Sure, generally higher sales can lead to greater cash flows, but that is far from certain. There are a lot of things that can impact cash flow. Before I can offer a realistic opinion on value, I have to see the cash flow.

An important part of justifying a premium price to a buyer is to build out a projected cash flow statement that demonstrates the growth potential of the business. Known as a DCF model, this financial model looks at the future performance of the business and converts the future value to present.

I spent a lot of time in business school building DCF models, and they can become complex quickly. I build them for clients now and they are time consuming. But they are essential to the business sale process.

If you’re at maximum capacity and booked 5 weeks out though, it is difficult to make a compelling case to a buyer that there is room for growth. Just hire another tech you say. If it was so easy, why haven’t you already done so? Which brings me to my next point.

  1. But I’m worth more because I have so much extra capacity the new owner will easily be able to double my current sales.

Having upside is great. But a business with 50% excess capacity not so much. Underperformance comes from many areas – outdated equipment, poor management, unmotivated staff, etc. As a buyer, why would I pay a premium for your underperformance?

If it is so easy to double sales, get out there and do it first. Then take your business to market.

  1. I’ve been working in this business for 30 years. Sweat equity doesn’t come free!

This may hurt to hear, but your sweat doesn’t matter unless it produces cash. A business is not a classic car that appreciates with value the longer you own it. If you want to create value in your business, i.e. goodwill that a buyer is willing to pay in excess of the value of your assets, you have to create a business with systems and processes that allow for sustainable future earning potential.

  1. Why would I sell at 4x EBITDA? If I stay in the business for 4 more years I’ll be at the same spot and still own my business.

This one is one of the more frustrating ones I hear because it is flat out wrong. It stems from a lack of understanding of fundamental financial principals.

If a business is generating $1 million in EBITDA, is offered a purchase price of $4 million, the after tax proceeds on a sale (assuming a 30% tax rate) are $2.8 million.

Compare that to the present value of $4 million over 4 years. Assuming a 30% tax rate, and a 18% discount rate (a conservative assumption indeed for a small privately held business), the present value of those cash flows are only $1.88 million.

Yes, you’ll still own your business at the end of that time horizon. But it will have cost you $1 million. And there is no certainty your business will be worth 4x at that point. As quickly as prices have risen in the past 3 years they can also fall as quickly.

But if you sell it today, you’ll be holding more money and carrying none of the risks that come with holding the business. This is exactly why people sell their business.

  1. I don’t need an M&A advisor to sell my business. The buyer says I don’t need one. Besides, my lawyer going to represent my interests.

You could also do the same thing when selling your house. The forms required to sell a house are boiler plate in most states and could be completed cost effectively by many an attorney. But rarely does that happen.

Business sales are anything but boiler plate. They are incredibly complex and time consuming. Attorneys are critical for legal review, CPAs for tax guidance. But M&A advisors shoulder a significant portion of the complexity of getting a deal done efficiently.

At a very basic level, M&A advisors provide a realistic assessment of value based on actual market conditions. Industry specific advisors, while maintaining confidentiality, can point to trends they see from specific industry experience in a way that even the most experienced attorneys and CPAs cannot.

But the most powerful and unique role of an M&A advisor is the ability to create an auction environment. An auction environment, whether real or perceived, drives buyers to pay maximum value for your business.

In an auction scenario, the advisor and seller have invested heavily in prep work known as seller due diligence before going to market. Because the advisor has run a professional M&A process previously, a buyer knows 1.) the seller is a serious seller; and thus 2.) is motivated to pay full price for the business for fear of losing out on the opportunity to a competitor.

What do you think? Have you experienced any of these situations? Have you found yourself saying the same thing? If so, I’d like to hear from you. But I’m interested to hear from you if you are looking to grow as well. What has your experience been on the growth side? Have you seen similar situations with sellers, and how has that impacted the deal?

Reach out to me using my contact page. All communication is confidential. Subscribers you can always respond to my email to get me directly.

Until next week!