A look at the bottom line
March 1, 2016 | By Mark Groulx
What kind of business has the best sales appeal?
There is a demand in the marketplace for HVAC/R businesses but who are the buyers? They are almost always bigger companies in the same industry. If a company is quite large, say $5 million in pre-tax profit, private equity buyers and private high net worth individuals will consider purchasing them.
In the contracting industry, it is usually bigger contractors or distributors in the same sector who are the buyers looking to grow by acquisition. Often times buyers are looking to diversify geographically so they can provide service to their existing customers in several locations.
Generally speaking, it is a strategy to accelerate growth. The buyer is looking to increase capacity by acquiring the company’s infrastructure, tradesmen and related skills to allow them to undertake more and bigger jobs.
In terms of what makes a company appealing to a buyer initially, in most cases it is the bigger the better. It is not top line or sales revenue numbers that are most important. It is the bottom line. The mergers and acquisitions (M&A) world is focussed on EBITDA (earnings before interest, taxes, depreciation and amortization).
This sounds like a mouthful but it is pretty straightforward. Go to your year-end income statement, look at the pre-tax net income then add any interest, depreciation and amortization on the statement and that is your EBITDA. Once the EBITDA is calculated, a buyer will multiply that number by a multiplier that is based on a number of factors, which are discussed below, to determine the purchase price. So guideline number one is to maximize your EBITDA, which is based on your bottom line profitability.
Once the EBITDA is calculated you want as high a multiplier on that number as possible because the result is the purchase price. The multiple could range from two times to eight times so a company with $1 million of EBITDA could be worth anywhere from $2 million to $8 million.
The single most important factor to increase the multiple is to show recurring revenue, that is, sales that recur year in and year out. Maintenance contracts are a very good example of this. If you provide ongoing maintenance to a long list of customers that pay you for servicing their systems several times a year, you will get a higher multiple. The more you can show to a buyer that revenues and profits will continue to occur in the future, the higher the multiple you will get. The opposite is project work. If all your work is bid/spec, project-based work you do not have much certainty of future sales or earnings.
Other factors that will help the multiple are steady growth trends. If your sales and earnings have been growing steadily in recent years, it is usually a safe assumption that this will continue. If the company is well organized with systems and processes in place that will also increase the multiplier. If there is a good management team (not dependant on the owner to be there to run the business), a good performance record (on time and on money), a good safety record, a minimal amount of “normalizations” and good record keeping – these will all contribute to a higher multiplier.
The infamous “normalization” calculation deserves a brief comment. It is not uncommon for business owners to put a fair amount of personal expenses through the company. These include spouses and relatives on the payroll who do not actually work there, vacations, cars and boats. Buyers will allow for some of these expenses to be added back to the EBITDA calculation but if you are preparing to sell your business you should try to have a minimum of personal expenses in the business. For all those expenses you take out of the business you will be paid that amount times the multiplier as part of the purchase price.
Selling your business is a complicated process. You need to prepare a Confidential Information Memorandum that summarizes your business, its ownership, management, employees, customers, suppliers, competitors, growth opportunities, as well as financial summaries of the income statement and balance sheet. This is the information a buyer needs to assess whether they want to buy the business and at what price.
You then need to prepare a buyer list that details the most likely buyers for the business and all related contact information. Next, a secure, password protected, online data room needs to be prepared to store all documentation required for due diligence. After all that is done in advance, you then have to negotiate a deal, which includes technical matters such as working capital adjustments, as well as numerous terms and conditions.
For companies with $1 million or more of EBITDA it is wise to get an M&A advisor to assist you and in fact, manage the process. For smaller companies it is advisable to speak with your accountants and lawyers to assist you in the process.
Mark Groulx is the president and founder of AIM Group Canada Ltd., business brokers who arrange mergers and acquisitions, divestitures and management buyouts across the country. He has led numerous successful transactions from origination through preparation, structuring, negotiation and closing across several industries in his more than 20 years with AIM. He can be reached by e-mail at email@example.com.