Foreword by Ranger Kidwell-Ross
Because the universe of power sweeping contractors is relatively small, it is often difficult to find baseline pricing information for buying or selling their businesses. However, there are basic metrics that apply to this industry just as they do to any others.
Soundcore Capital Partners, LLC is a New York-based private equity firm that is in the business of buying and selling companies. Further, the organization has identified the power sweeping industry as one of interest to them. Currently, Soundcore is actively pursuing the acquisition of power sweeping contractors throughout the United States.
As a result, WSA asked one of the company’s principals, Erik Emmett, who is an attorney as well as Soundcore’s Head of Deal Origination, to provide World Sweeping Association Members with an overview of their process, along with any tips he has for how contractors may improve the viability of their companies prior to putting them on the market.
To facilitate this, the WSA website offers both the written article you will read below and an approximately 30-minute audio interview I held with Mr. Emmett in late March 2016.
by Ranger Kidwell-Ross with Erik W. Emmett
First, for those who may not know this already, a private equity firm is one that buys and sells privately held companies. Different private equity firms focus on different size segments, as well as different types of industries. At Soundcore, we focus on the lower-to-middle marketplace, which is comprised of companies from $100 million in annual sales down to $1 million and, sometimes, even less. In the private equity industry, we consider those to be small companies.
Often, private equity firms will purchase a number of small businesses and then add them together to form a larger company. Soundcore, like many firms in the private equity field, usually likes to hold the companies we purchase for 3-to-5 years, during which time we work to grow each of the businesses. Then, the grouping of similar companies are sold, often to another private equity firm that focuses on larger businesses. It’s sort of like a small fish being eaten by a larger fish farther up the food chain.
Private equity firms differ from another type of business purchaser commonly called a “strategic buyer.” A strategic buyer would be someone already in the pavement maintenance field. It might be a larger sweeping company or it could be another type of commercial contractor that is doing any number of somewhat similar functions. For example it could be a facility maintenance firm or any other similar company. Typically, a strategic buyer is larger than the companies they might purchase.
When it comes to buying or selling a company, most small business owners have not gone through the process before, or been part of an acquisition themselves. As a result, there is always uncertainty on behalf of the sellers in terms of, number one, what kind of valuation they should be able to get for their business from an outside private investor; how their strengths and weaknesses will be assessed; and, how those strengths and weaknesses will ultimately affect the overall purchase price of the company.
Secondly, business owners want to know how best to prepare for potential sale. A lot of owners like to think that they will eventually sell to their management team, pass the business onto their family, or sell to another third party. The fact is, knowing how best to position the company can be of great importance when transferring ownership in any of those ways, regardless of where the business is in its life cycle.
It is important for other reasons, as well. Whether you are approaching a lender about providing a line of credit on the business or applying for a business loan, you obviously want your business to be on as strong of a financial footing as possible. You also want that to be easily reflected from an accounting standpoint. The item that is of primary interest when we evaluate a business is called its EBITDA; that is, the Earnings of the Business before Interest, Taxes, Depreciation and Amortization.
A company’s EBITDA gives us an essential sense for how much cash the business is generating. That is the financial metric that financial firms across the country use to value businesses. A buyer like Soundcore will always seek to adjust a business’s EBITDA so that any personal expenses or non-recurring purchases are added back to the bottom line, increasing the overall purchase price. Once an adjusted EBITDA is arrived at, the buyer will offer the seller a multiple of its adjusted EBITDA which equals the purchase price.
Another metric that is typically of consideration when evaluating a business is the customer concentration of that business. This simply means how many total customers comprise the customer base of your business. Here’s why: Just having a few customers increases the risk in the business, since the impact of losing any particular customer is more dramatic in terms of what kind of sales drop would result. As a result, businesses with a wide array of customers are typically valued somewhat higher.
Another metric we look at is the history of performance. At Soundcore, we really prefer to invest in businesses that did well in the downturn as well as that have a historical growth trend. That is not to say we won’t look at businesses that have had valleys and peaks, so to speak. However, a strong history of year-over-year growth will often increase the multiple of adjusted EBITDA that a financial organization is willing to pay.
Something else we look at is the industry at large. For example, Soundcore became attracted to the power sweeping industry because it’s an industry that has not experienced many headwinds. In addition, we believe there are a lot of tailwinds in this industry’s future. We know that a lot of companies in the power sweeping/pavement maintenance industry continued to do well in the downturn. Businesses that are in healthy industries, for example companies that don’t have too much oil and gas exposure (even though there is a component of that in the power sweeping industry it’s not a major factor) will help to increase the value of the company, as well.
The market position that a particular company has in its local marketplace is also something that is important. The management team of the company needs to be able to defend why they have the particular market position they have attained. A potential buyer will always be interested in what percentage of the market you currently have as a part your business. In order to have that information available you need to determine the answers to basic questions like “Exactly what is your market?” Having a good grasp of what your market consists of, as well as what percentage of the total available business in that market that your company has captured, is very valuable information when it comes time to sell. “What is your market saturation?” is a question you should always expect to be asked up front.
It’s important to be able to define your market position and, perhaps obviously, the greater market share you have the more attractive your company will be to a potential buyer. To get a sense of the market position for larger companies, one might include a review of social media, search engine results and that sort of thing. For smaller companies, such as most contractors in the power sweeping industry, it makes sense for company management to come up in advance with some way to explain your market saturation.
For example, you might take a look at the top 100 retail plazas in your area and report that you service X percent of those establishments. If you service the majority of those plazas in your market area then that would be a very defensible position, and a good way of describing the professional reach of your company. That sort of information is very helpful to any potential buyer of your company.
If your business model also includes doing street sweeping for local municipalities, and you show that you do a high percentage of the available work in your market area, that will be something that will increase your attractiveness for a buyer. These are the types of research that takes some legwork on the part of the seller; however, it will pay dividends if you can highlight your market position effectively.
Another important factor is what might be called the loyalty of your customer base. What we do in this regard is look at several years of financials and review or develop a breakdown of where the revenues came from. In that way we will be able to see, year-over-year, how much of your sales were attributed to Customer A versus Customer B, whether sales declined year-over-year, etc. Much of that process comes down to due diligence and analyzing historical financial records.
After performing an overview analysis of the power sweeping industry here at Soundcore, we determined that we liked the industry for several reasons: For one, generally speaking there’s typically lots of market share to be gained. We also believe there will be significant growth in this industry. Power sweeping is also an industry that is relatively non-cyclical and, by nature, highly recurring. Also, for us, we are most interested in purchasing small businesses, ones between $1 million and $100 million in annual sales, and many power sweeping contractors fall in that area.
When it comes to selling a business, or evaluating a business that’s for sale, the above type of considerations will be important in determining an original offer. And, most times, you will find that any final offer will be pretty close to the initial one if the offer has been made by a professional company, since they will have reached their conclusion based upon objective information. Whatever that potential purchase number is, it needs to be one where both the buyer and seller are comfortable with moving forward. Remember: The more prepared you are, the better you can show off the value of your company — and that can help you drive your initial discussion about valuation higher. Having strong knowledge about the market position and financial aspects of your firm can help in negotiation process.
Something else that can affect the selling price of the business is something that we refer to as “deferred CAPEX,” or deferred capital expenditures. For example, if your business has not been maintaining its fleet; has not been replacing equipment so it has trucks that are 10 years old or older, that would be a business that I would consider to have deferred CAPEX. If a company has primarily old equipment, or poorly maintained equipment, can weigh down its valuation
Naturally, any buyer will have to consider how much they will have to spend, moving forward, to bring the business back up to where it should be. Ensuring that all of your equipment is up-to-date and well-serviced will improve valuation. This goes back to the overall concept of EBITA and the opinion someone will have about your business.
A lot of sellers think, “Well, I don’t want to buy a lot of new equipment if I will to be selling my business because that’s going to reduce my EBITDA.” For that reason, if you’re thinking about selling in the future it is often best to finance large purchases. That is usually the best way to assure that your EBITDA is as high as it should be. I know that a lot of small business owners don’t like to have any debt whatsoever. To achieve that, they buy things with cash.
When we value a business we will look at the cash expenditures. If we see that a truck was purchased with cash rather than financed, we will factor that in to the adjusted EBITDA when making our valuation. Some buyers may not be sophisticated enough to do that, though, so when you’re preparing your business for a future sale you should consider whether new capital expenditures should be purchased with cash or, alternatively, whether financing them would be better. Just because you are contemplating the sale of your business doesn’t mean you need to quit investing in it on an ongoing basis.
There are reasons to sell to either a private equity firm or a strategic buyer. Selling to the latter, you will often need to seek out possible buyers in your general area. Also, unless they are already in the market, they need to be shown why they should expand their operations to include your business.
By contrast, private equity firms are growth-oriented and are typically interested only if they believe they can achieve a particular investment goal over the course of, say, 3-to-5 years. At Soundcore, for example, we often provide an opportunity for the owners of a business that we buy to invest alongside us in the multi-business platform we are developing for resale. We also believe it is good business to keep management teams in place after the sale.
Unlike with private equity firms that specialize in the larger marketplace, in this one you don’t really have those ‘slash and burn’ type companies that want to buy a company and then change everything. What we do want to do is augment management in order to grow the business more effectively. Because we are buying multiple businesses and putting them together, we need to retain all the resources we can to achieve our business aggregation investment goals. Strategic buyers, however, often want to replace the entire management with their own management team to reduce overhead.
With a private equity firm that is purchasing businesses in a particular market segment, such as Soundcore is doing in the power sweeping arena, there are always opportunities for current managers to participate as we purchase individual companies and turn the combined group into a national organization.
The creation of a large aggregated business can often bring positive changes like increased buying power and the ability to offer expanded benefits to employees. Under the Affordable Care Act, businesses with more than 50 employees are required to provide healthcare to every full-time employee. At Soundcore we are excited about professionalizing companies and offering expanded benefits. We always offer very competitive pay structures, ones designed to incentivize the management teams of the companies we purchase, since we want them to be excited about growing the business with us.
When you, the business owner, want to plan ahead to package your company for a future sale, it can present you with some hard choices. The mantra of most business owners I know has always been to grow their business. However, one of the important things to think about when you’re considering selling your business is how to direct focus on doing what it takes to increase your bottom line. For packaging your business for sale, focusing on the bottom line rather than the top line is really the most important thing.
You should think about expenditures used to drive growth and market share. These could be things like adding on to your fleet or bringing on new employees. Focusing on how new expenditures will effect EBITDA is always important.
You also want to get comfortable with your financials, and see that they grow month-after-month. Be diligent about making sure that you’re getting the results you want and develop a dedicated plan on how to get there. Notifying your accountant that you are considering a sale will often help the process and will give you an understanding of your EBITDA. I also recommend consulting a lawyer to make sure that the business will look clean to any potential buyer from a legal perspective.
Often business owners believe their businesses have a particular worth, but don’t always have a particular metric for how they arrived at that amount. Other times, they are reluctant to sell because they are in a growth pattern and think to themselves “We are growing at 10, 20, 30% per year, so why would I want to walk away from that?” An advantage of working with a private equity firm can be the way they are able to structure transactions. The sale of your business can be structured so that the current owners can receive full value for the business while still be compensated for future growth. This is done using what is called an ‘earn out.’ In addition to paying a set multiple of the EBITDA, firms can pay additional value once that business reaches a predetermined threshold.
This is a way for the owner to get what he or she perceives is the correct amount for the business and it also aligns with our interests. We want to see owners and managers continue to grow their businesses post-sale, so we are happy to pay for that post sale because it means we’re all winning.
When you go into a potential sale situation, it’s important to utilize an attorney with experience with mergers and acquisitions, and this may not be your current business attorney. Attorneys that do not have the requisite transactional experience can really slow down the process. If you have friends or business acquaintances who have sold a business you might want to work with them to get referrals to competent attorneys who can help speed along your process.
An organization that’s interested in purchasing your company will want to see at least a couple years of Profit and Loss (P&L) statements as well as balance sheets and a breakdown on your Selling, General and Administrative (SG&A) expenses. Just with that sort of limited information firms are able to develop a fairly good estimate of the kind of multiple the business is worth. And, of course, all the factors I’ve mentioned earlier about how a business is being operated also come into play. All of those combine to point the purchase price of the company toward the higher or lower end of the range of EBITDA multiple it is worth.
In terms of our process, we take a look at the financials and any other readily available information that provides us with the baseline data that we need, then have a frank conversation with the business owner about the general sales price that we think the business is worth. If we find that we are close in our assessment to what is acceptable to the business owner, then we visit the business, meet the owner and see the operation in-person. That is always important.
Does your business have special situations? Many do so don’t worry about that. A number of the businesses we have purchased have had special circumstances that needed to be considered. For example, you might have a family member that must be retained while they’re going to college, or myriad of other individualized factors that can be accommodated. Of course, any promises made only last the projected 3-to-5 year time frame for retaining the business as a component of a larger organization being built for eventual re-sale.
In the spring of 2016 when this article was written, and podcast recorded, the NY-based Soundcore Capital Partners in which Mr. Emmett is a Principal had identified power sweeping contractors as a market segment in which they wanted to make purchases. Whether you would like to explore selling your sweeping company or have questions on the topics that were explained in the above article, feel free to contact Erik Emmett directly. His direct phone line is 212.390.4149. Alternatively, you may reach him via email sent to email@example.com.