Over the last two years, Beacon has witnessed a large increase in merger and acquisitions (M&A) activity in the specialty contracting business that includes roofing contractors. This boom cycle is beginning to resemble the high multiples witnessed in 2005 to 2007.
The activity is fueled by low interest rates, the return of the profit, larger companies and other private capital seeking closely held businesses as an alternative means of achieving greater returns on their investments, plus the banks beginning to loosen their underwriting criteria.
These trends usually come in waves lasting six to eight years. This will end and one could speculate that baby boomers are on the verge of the next best window for selling their businesses before another recession descends upon us. Missing this window could put them well into their 70s and in a difficult position 10 years from now trying to catch the next cycle in the early 2030s.
Presently there is a lot of private equity money and consolidators looking to acquire attractive roofing companies. But you need to go into this with your eyes open, if considering a sale to an outside buyer.
A study by the Chamber of Commerce revealed that fewer than 20% of companies that go to market actually sell. The statistics are closer to 10% with contracting companies. You can increase your odds of success by getting your company “sale-ready” with the help of an adviser. Early preparation and assistance from an exit planner or an M&A adviser would include:
- A market study to review your company’s financial strength, efficiencies, competition benchmarks and potential buyers based on your size, location, niches, and synergies.
- Due diligence pre-game review to eliminate all the distractions and issues that could kill a deal.
- A market strategy to position the company in the best possible light to a buyer and emphasize its strengths while differentiating it from the competition.
The 10 keys below are sound business practices in preparing your company for a sale, adding value to your company whether you sell to a competitor or investors. The 10 keys will focus on an external sale (outside buyer/consolidator or private equity).
1. Valuation
Get your company appraised by an accredited business appraiser. This exercise will allow you to determine and understand what creates or detracts value in your business. Remember, each external path has a different value (called “range of value”) and different tax ramification that can erode your proceeds by over 55%. An accredited appraiser can show you not only how the company is valued, but how the various classes of assets or stock will be taxed.
Bottom line, the owner needs a realistic understanding of the value of the business as well as the tax ramification of the transaction. These are critical components in setting realistic expectations for the seller to realize success in the transaction and achieve post-exit financial goals.
2. Jump Start
Start the sales preparation process by meeting with your adviser (exit planner or M&A adviser) a year before you are ready to sell. This time will give you the opportunity to properly align all the moving parts in the sale process. Much like selling your house, you will need time to “dress up” the business so it looks attractive to potential buyers.
The dressing up does not simply mean clean the facility but also cleaning up the financials. This will be critical in successfully completing the due diligence process with minimal adjustments by the buyer. A professional adviser will assist you in the “clean up” process by showing the seller the areas of improvement.
They will also assist by creating a “marketing book” for your business. The marketing book will be a commercial for your business, outlining the strengths and weaknesses of your business with special attention and focus on the strengths.
3. Do Not Go Alone
Do not deal with potential outside buyers by yourself. For many, transitioning a business is an emotional process. A lot of time and frustration can be controlled by an exit planner or an M&A adviser in qualifying the buyer while giving you the time to ready yourself for the sale.
Ideally, you want several potential buyers competing for your business. Buyer representation is critical to assist with this negotiation for the best possible price and terms, manage the process and keep the emotions away from the process.
4. Succession
Replace yourself with a team that can operate the company without you. This will require systems that measure results in consistent quality and efficiency that affect the bottom line. You will need a strong management team and bench strength to make your company more valuable.
Remember what the buyer wants in your business is not the equipment, the facility, or the products. They want the cash flow, and your people will be instrumental in helping transfer that cash flow to the buyer with reduced risk.
Consider locking in key managers before going to market with something like a deferred compensation plan that creates golden handcuffs to secure the managers after the sale.
Private equity are investors who will want the owner to stay engaged in the management of the business.
Consolidators usually need the owner for a shorter period, will implement their financial and operating systems besides trimming waste.
In either case, the owner will lose control of the company.
5. Change the C-Corp to an S-Corp
Consider making the election to change your C-Corp to an S-Corp. There are distinct disadvantages to transitioning your business while being a C-Corp, one of them being the double taxation inherent in the C-Corp structure and the other being the built-in gain tax that stays with a corporation for 10 years. The built-in gain tax essentially eliminates the capital gain tax treatment for an S-Corp that was previously a C-Corp. Early planning will help you avoid this pitfall.
6. Recast Your Earnings
Private owners need to clean up their books and recast their financials to reflect normalized earnings by adding back discretionary expenses. This can include such items as salaries/bonuses paid to family members, business vehicles, memberships, travel, and entertainment.
These are items that would not necessarily be incurred by a buyer and will lead to a “normalized” earnings potential for the business. If at all possible, these expenses should be eliminated from the financials altogether because these adjustments are usually a point of contention with the buyer, as they are often difficult to prove.
Yes, your financial strength and future cash flow are central in the valuation and pricing of your company. But what niches and highly profitable aspects of your business will differentiate your company from the competition? You must be able to tell a story in your marketing position that is clear and measurable and that defines your competitive advantage. This is an aspect of the sale that can increase your “multiple” for a higher price.
8. Clean Up Any Distractions
When you sell a house, you take care of things before the sale that you may have learned to live with but that would distract the buyer. The key is to clean up any “maintenance” distractions and to disclose everything that could cause a surprise that could kill the deal.
The buyer’s due diligence process will examine a lot more than just your financials. They will look into every corner of the business, including key contracts, supplier agreements, legal agreements, insurance policies, company health and pension plans, human resource policies, corporate records/minutes, etc.
The key is to perform the pre-due diligence before going to market. The adviser role is to present the business from the buyer’s eyes to make everything as clear and transparent as possible with as few distractions as possible.
9. Be Prepared to Negotiate Terms
Every deal is different, but these items are negotiable and will determine the price:
- Will you keep some of the assets in the deal, like an auto or truck?
- Will you be paid in a lump sum or installment payments?
- How large of a down payment will you require and what will be the length of the installment payments?
- Are you flexible on selling the assets or equity?
- Are you willing to work for the buyer after the closing as a consultant or manager?
- Are you willing to sign a non-compete agreement and the limits of restrictions?
- Are you willing to finance the balance of the transaction?
- Are you willing to earn the balance of the sale price?
The devil is in the details. While you may think you are getting a good deal, the details of the transaction will play a critical role into how much you will actually receive.
10. Pedal to the Metal
The buyer does not want to see shrinking margins or a loss in sales during his diligence. The owner needs to continue driving the business and let the M&A professionals drive the sales process and manage the buyer — this is what they do. All too often we see owners who have one foot out the door, only to see the deal go south. He is now left with a declining business and very little opportunities to sell. It is best to keep the owner at arm’s length from buyers in the due diligence and bring them into the critical negotiations period at the end of the process.
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