Let’s say that you’re just itching to get a second shift going for a value-added production facility in your lumberyard. Or you’ve already got a second shift running at your facility, but it’s been running only for, say, three months. In this example, the value-added production facility is a truss plant, a door/window shop, a wood-treatment plant, a millwork operation, etc.
The reason you’re eager to get that second shift going? Well, you’ve already made the capital expenditure in the facility for the first shift. It’s going great. You’ve hired the right staff, and there’s a market for what you will produce. So, adding the second shift is a no-brainer.
But there’s another reason you want that second shift producing those extra earnings. No one around the shop knows it yet, but you’ve been talking with a potential acquirer, and you want the Adjusted EBITDA contribution from the second shift to get full consideration in the total enterprise value (TEV) paid for your company.
In this example, assume that each shift adds $1.2M in Adjusted EBITDA. This potential acquirer is offering 6X of the trailing 12-month (TTM) Adjusted EBITDA as an acquisition price for your company. Also assume that you’re already generating $4M in Adjusted EBITDA, without the second shift fully contributing. When the second shift is fully up and running, your Adjusted EBITDA moves from $4M to $5.2M.
Here’s the dilemma: From a TTM perspective, the second shift has been running just three months, contributing three-twelfths of the EBITDA it would deliver over a full year. In this case, that portion is equal to $300,000. You, the seller, are rightfully worried you’ll be leaving money on the table if you sell now, because you’re getting just 6X $300,000 for the new second shift, when you want 6X $1.2M for the full year’s credit!
You could wait for the second shift to run a full 12 months, but you’re not sure the acquirer will hang around that long. He’s insisting that 6X is a premium … and you know he’s right. He wants to ink an LOI now.
The various scenarios are:
1. The company acquisition value without the second shift in the mix: 6X $4M = $24M.
2. The company acquisition value with the second shift running one full year: 6X ($4M + $1.2M) = $31.2M.
3. The company acquisition value with the second shift running just three months: 6X ($4M + $300,000) = $25.8M. That’s a $5.4M drop in acquisition value just because the plant hasn’t run a full year!
Risking an extraordinary dinner and flower bill for the up-coming weekend, the seller complains to his wife that he’s losing sleep over this. She says, “Stop taking your problems to bed.” The seller says, “But I’m married to my company!”
What’s the best way forward?
If this seller were our client, we would first counsel patience. Wait for the full year’s performance on the second shift, and then sell. Other acquirers will emerge. Heck, you may get more than 6X with that increased Adjusted EBITDA.
If the seller insists, the second thing to do is ask for a higher multiple from the acquirer, on the promise of the second shift. The “ask” would be 7X of the $4.3M TTM Adjusted EBITDA figure, essentially achieving what the company would be worth with the second shift fully contributing.
But the acquirer says 7X is a no-go; he’s already on his tippy toes at 6X.
Well, as uncomfortable as it is for the eager seller (since it’s not money in hand at close), the seller should consider taking a purchase price of 6X the $4M Adjusted EBITDA, and an earn-out. The seller would get $24M at the closing (minus the required 5% escrow) and get the 6X multiple on the second shift actual Adjusted EBITDA 12 months after the close.
All sellers in this situation will say, “But what if the second shift doesn’t perform as expected?”
But that’s what the earn-out is designed to do: the acquirer limits their risk by paying on performance, while the seller—who very likely becomes an employee under new ownership—is highly motivated to make everything work as expected, because that’s when, and only when, he’ll get paid 6X on that second shift premium.
