Every day, investment bankers like us get two or three email requests from funds and strategic investors looking to acquire successful companies. Ironically, with all this capital, and a clear bias for acquisition to put money to work, some LBM business owners grow frustrated when they can’t interest an investor, or even sell their company outright. Now, with talk of an economic slowdown as soon as 2021, owners who don’t want to wait out another business cycle are eyeing the exits.
The thing is, acquirers didn’t get to be in charge of mil- lions through imprudence. Their risk tolerance is very low. They aren’t in the market for just any company. They are in the market for the right company, which they define for themselves. Accordingly, they have strict investment parameters and minimum performance thresholds.
What are those thresholds? They vary. The “floor” for the smallest deals are usually $2 million in EBITDA, yet it’s often two or three times that figure. That floor seems to be the consensus that puts investors at ease that a company is putting decent money on the bottom line. (And remember that’s in addition to strong growth, solid margins, a great brand, leadership succession plans, etc.) Knowing that most of today’s LBM businesses are acquired for around 5X EBITDA (or a premium above that for strategic purchases, and even higher multiples for larger businesses), we can estimate the deal values would start around $10 million and range upward from there. (These multiples change when a public company is involved.)
We can already hear the screaming: You mean I have to be profitable by a $2 million margin to get someone interested?
Yes, that’s largely true. Companies that are not profitable or only marginally profitable yet show promise and are in high-growth regions may achieve a good value in an acquisition. But in those cases, the buyer and seller would have to agree to base the value of the company on a multiple of future EBITDA, with an earnout in place for the buyer’s protection. The risky part of earnouts? They sound great, and everyone is thrilled at the closing. But then the acquirer may restrict marketing dollars, or cut the sales force, or change commissions structure, impeding the seller’s ability to hit the very EBITDA targets they just agreed to.
That said, the go-go days of 2005 and 2006 are long gone, and sky-high values are rarely paid for companies that are under $2 million EBITDA. Investors now stick to basics: Target companies are valued on a multiple of an averaged, historical EBITDA or a multiple of trailing twelve-month (TTM) EBITDA.
The reason for this explanation of risk and value is that many company owners simply want to sell too soon, often long before an acquirer would recognize the value that the company owner is convinced is staring everyone in the face. We understand the emotions here: Businesses take a great deal of personal energy and sacrifice to run. Cash flow is often a challenge, and company owners can get exhausted with so many people dependent on him to “pull a rabbit out of the hat” every time payroll gets run or a supplier has to be paid. So, when they start to put up some decent numbers, e.g. $1 million in profit, or $1.5 million in profit, an owner will call us and say: “I want to sell. I know I might be leaving some money on the table…” yet they cite a target value that is probably beyond what can be reasonably attained, say, 8X $1 million, when a more realistic multiple for a company that size is around just over half that. The founder sees value and little risk, whereas the investor sees a great deal of risk. So, as painful as it may be, we urge company owners to plan their exit strategy around targets of at least $2 million adjusted EBITDA as a starting point, if they want to attain solid values. Anything sooner is perceived as rushing for the door…and resulting valuations will indeed suffer, if a deal can get done at all.