"He's back, Henry, that nice boy in the Dockers
and Armani glasses who wants to buy our business."
"Tell him to go away, Marge. I don't want to sell
the business."
"But he's doing a buildup, Henry. We can make lots
of money. Besides, he says if we don't sell he is going to buy our competitor
and crush us like a grape."
"Tell him if he can get to seven times adjusted
EBITDA, vested options and a five year employment contract he can come
in, Marge. Otherwise, go away. I didn't just fall off the turnip truck
you know."
Build-ups - sticking a half dozen little companies together
to sell as one big business -- are the rage in private equity. An army
of EBITDA missionaries -- young, smart, ambitious dealmeisters who can
calculate IRR's in their heads -- are canvassing America like the encyclopedia
salesmen of the 1950's, conducting a house to house search for cash
flow.
Eighteen years of low inflation and falling interest
rates have left investors starving for future cash flow streams. They
have already gobbled up every big business in sight - now they have
their sights on the little ones. Like peasants after the harvest, investors
are gleaning for dollars, lowering their size requirements to the level
that works in today's picked-over market. That's why small-cap stocks
outperformed large cap stocks in the second quarter all over the world.
Sometimes a buildup makes great sense, an honest 1+1=3,
where there is an opportunity to build a strong national franchise out
of inefficient, regional businesses. But sometimes it is a game played
with mirrors and spreadsheets. To the owner of a family business this
is the difference between a home run and a wipeout. Before these young
men knock on your door, as they surely will, here are a few things to
think about.
In a buildup, an investor first buys a platform company,
the cornerstone that serves as the first piece of the puzzle. Then the
investor identifies a list of smaller add-on acquisitions consistent
with the firm's growth strategy. The add-ons are integrated into the
platform company's operations to capture synergies, opportunities to
improve profits by combining purchasing, back office, or customer service
operations, or by cross-selling products. Then the new ersatz company
is sold for a larger multiple to the next owner.
Most owners of small companies when approached by investors
to do a build-up spend all their energy worrying about the deal they
will get from the investors. This is a mistake. The important thing
is whether the buildup makes sense, i.e., whether the resulting company
will be successful in the market. You will still be working there after
the transaction. If you own the Platform Company, your name will still
be on the building. Your reputation with employees, with customers and
in the community is at stake. More than likely you will still have a
large part of your net worth tied up in the stock.
The most important thing is to make sure the people who
buy your company are honorable. Make sure they believe in your dream.
Make sure they have the capital and other resources you need. Check
their references with owners and managers they have dealt with before.
I made this mistake once and wasted three years in a boardroom with
people I didn't like. I will never do it again.
Make sure there is a control investor to provide direction
and resolve conflicts. Buildups require swift decisions. Situations
where everybody is a minority shareholder degenerate into endless bickering.
Choosing the right platform. The company should be a
respected, industry leader. It should have returns on capital over 20%.
The boss should be known in the industry as both a creative thinker
and a strong operator, and should have experience managing integrations.
I once picked the wrong platform and helped a weak company acquire a
stronger competitor. Both groups of managers were unhappy; the results
were not good.
If you don't have a senior manager on board who has experience
integrating acquisitions hire one or rent one. Managing integration
is a special skill, and is not the same as managing operations.
Make sure you have strong financial and information systems
with capacity to fold in acquisitions. Consolidating an industry accelerates
change, temporarily depresses margins and increases risk. You can't
afford to fly blind in a changing industry. Besides, today accurate
real-time information is a competitive weapon.
Deals where the managers don't buy stock don't work.
Expect to re-invest 20-30% of the value of your company in the new company.
Make disciplined acquisitions. Once the word is out that
you are leading the consolidation of an industry, potential acquisitions
will come out of the woodwork. Stick with your plan; you can't afford
the distractions.
Watch out for overhead. A buildup doesn't need a headquarters,
corporate staff, or expensive perks. Every dollar you can put on the
bottom line will mean six to eight dollars in your pocket at the next
sale.
Your equity investor -- your head coach -- should bring
more to the table than capital. His coaching staff should help you solve
the big questions you will face. Looking over our own portfolio companies
I find that we have been involved with marketing, licensing, product
development, international distribution, foreign sourcing, direct mail,
e-commerce and recruiting issues.
With all this work, why do it? Because the rewards are
tremendous. The owner of a $40 million business with $2 million in EBITDA,
can sell his stand-alone business at a five times multiple for $10 million.
By combining his company with several others to create a successful
buildup with doubled EBITDA margins, and selling the larger company
at a 7x multiple, his $4 million of EBITDA will be worth $28 million.
Pretty good reason.
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