buy side PE - how to buy a business

[Music] today we are going to talk about buying a pest control business you know here at potomac we do on average of 50 to 60 transactions per year around the globe and i get a lot of questions about the buy side of m a and that's not a service we provide we're largely sell side advisors but often our clients you know we've got hundreds of clients that are in various different stages of the process of ultimately selling their business look to make acquisitions and i get questions every single day about how to value a business how to buy it so that's what i wanted to talk to you a little bit about today you know when i think about buying a pest control business i guess the first thing that pops into my mind is what's your strategy with this what's your goal why would you consider buying one in the first place you know is it an add-on acquisition you're basically filling in density in your current market are you trying to enter into a new market for example buy a business in a separate city to give you a jump start in creating a footprint in a new city there's a million different reasons why you might want to buy a pest control business but i think some of the main problems that i see right out of the gate when folks start to talk about valuation is they frame the evaluation discussion in their mind with what they've heard about what a renai kill or terminax orkin or any of these other big acquirers are doing out in the market and look if you own a pest control business you don't have the same resources as rollins right you don't have the same resources as terminix and quite frankly the value that you can create from a deal is not nearly as much value as these guys can create from a transaction so you have to go in this and be i think extremely conservative when you start to frame up this discussion and we're going to talk about that it's going to be a big part of our discussion today is actually talking about how to value these smaller acquisition targets the other question that i i often pose our clients is are you opportunistic in your acquisition or do you want to develop a formal m a program and here's what i mean by that i think there's a lot of people out there running a business and they get the phone call someone so passed away so-and-so is ill so-and-so wants to retire and there's a five or six hundred thousand dollar pest control business across town do you want to buy it that's the majority of the folks that ask questions are opportunistic right they're in the right place at the right time they have an opportunity to do a deal the other end of that spectrum is growing your business through acquisition which is creating a formal acquisition program creating the capability to go out and source transactions so source deals tying it to a strategy as to how you're going to grow your business and then ultimately execute i'm going to talk a little bit about both of those today but really what i want to focus on right now is where i think most people find themselves which is really in that opportunistic position the first question people often have is okay so how do i even value this and i would typically put the valuation discussion entirely aside get an opportunity to sit down with the seller to understand first off does the business actually tie in to what it is that you're doing i think there's a lot of problems that come up over time when you make an acquisition of a business that might have a very different service frequency it might have some employees there that don't really mesh with the type of business that you run remember a lot of small businesses out there remain small don't create opportunities for their employees and their employees ultimately self-select if you're a young guy and you've got the opportunity to work for a fast-growing company that provides a lot of opportunities or your alternative is to work for a 500 000 business that's not growing at all and it's been around for 30 years i mean there's a lot more excitement working for a large faster growing business so a lot of times those employees self-select meaning they're okay with being in the status quo in that small business so you know the first step is really understanding the motivations of the seller and really assessing the mix between the target business and ultimately your business and and i think some of your front-end work should really be focused on the types of services they're doing right the frequency of services is a company that's largely general pest is it residential is it commercial are you just buying accounts are you actually buying capabilities and and that'll really come into play when we talk about valuation but i think one of the main distinctions you have to make up front is am i buying an actual standalone income producing business or am i just buying a bundle of accounts once you get a sense for what sort of business you're buying and you look at it and say look services make sense i'm going to be able to you know a typical deal like this would increase route density right you've got your service footprint let's say you're doing two million a year find a 500 000 operation that you could tie in the most value creating acquisitions for small acquirers tend to be these density plays so you've got the target company might have gross margins of 50 and that's basically revenue minus direct costs and your business let's say you've got a 60 gross margin and once you combine the two of those businesses you might get an incremental uptick in your own gross margin of maybe 50 or 100 basis points so to you up front it looks like it makes strategic sense you know the next question ultimately comes down to how do you value these businesses and you know a typical valuation metric is a market approach right a transaction multiple we've all heard you know pest control companies tend to sell for x times revenue or x times cash flow um and and there's a myriad of multiples that just get sprayed around the industry i would if i were in your position avoid thinking about things in terms of multiples and actually try to get a little bit more sophisticated as to how you're valuing this business i wouldn't concern myself first off with competition coming in and out paying you know at the end of the day your return is set based upon your purchase price your entry acquisition so you need to be very conservative when you frame up the discussion with the seller and when you think about it from a valuation perspective you really have to look at what is it that i'm buying i'm buying a stream of cash flow into perpetuity and you need to value that stream of cash flow you know in the business valuation arena we talk about standards of value and they're actually quite simple to think through there's two that i want you to continue to have in your mind you have fair market value and you have investment value or otherwise called the strategic value right so there's two of them and the fair market value of a business is what the business is worth to the current shareholders nothing more it's just what is that business worth on a standalone basis and then the investment value or the strategic value i tend to use those interchangeably the investment value of the firm is what that business is actually worth to you the acquirer and typically there's a range usually fair market value will be substantially lower than the investment value and there's what we call a value creation zone in between between the fair market value and the investment value in in any sort of m a transaction the seller wants to sell for as close to investment value as possible and the buyer wants to buy as close to fair market value as possible and so the two goal posts are where a lot of the negotiations take place so what i'll typically tell our clients is look before you start thinking about what the business is worth to you you need to start and think about what the business is actually worth to the selling shareholders i'm having this discussion right now at the end of july 2022. we're in a market that valuations are beginning slowly but surely to roll over and when you think about what goes on in the market it has been a very very busy market the last three or four years even today there's a lot of strategic acquirers private equity firms making acquisitions and they're focused on larger assets so pest control businesses that are less than a million dollars in revenue tend to have less competition from buyers for example rent-a-kill anti-cmx the large strategics in the industry are not spending a lot of time looking at five and six hundred thousand dollar businesses which is great for you because you're unlikely to have competition from the big players secondly the competition that you will have will likely be regionals and other small businesses those guys typically don't have much more experience doing deals than you do so you're not going to really be behind the curve competing with very sophisticated acquirers looking at smaller deals so you know my rule of thumb is i don't care if your business does a million in revenue or 50 million in revenue i think a lot of the value that can be created in these deals by not only getting involved in processes that don't have a lot of competitors a lot of other buyers is these smaller deals really the kind of the eight hundred thousand to three hundred thousand revenue range is a real nice sweet spot for a private acquire when you think about the fair market value of the business it's important to think about you've got the revenue less the direct costs then you subtract the operating costs and you're going to come to some sort of proxy of cash flow we call it and in very basic terms trying to understand what the pre-tax earnings of the business is and it's very common for owners to attempt to add their compensation back into the p l now what i say on the buy side and what i say on the sell side are two very very different things so when you hear me talk about sell side m a i want to throw the kitchen sink back into this but if i'm investing my own hard earned money i'm going to make sure that the p l the income statement that i'm looking at reflects the true costs in the business and you know owners will often times especially for smaller businesses not pay themselves or they might pay pay themselves a very small salary in order to avoid unemployment taxes and and so on and so forth and it's important to really understand from the get-go what sort of economic benefit is the owner actually providing to that business so if the owner is paying himself 30 000 a year um but based on all your knowledge of the industry and what it is that you understand that he's doing after discussion he should be paying himself 85 000 or 90 000 a year you're ultimately going to have to replace that and so once you can effectively normalize a p l and you know over the course of the next couple of months i'm going to provide a financial model for folks in the industry who want to do acquisitions it'll be free you can subscribe to our commentary at potomacpestcontrol.com get yourself on the list and we'll send it around but once you build your model and you normalize the cash flow and you say okay i have attempted to make this p l look like a market deal you're gonna come up with some sort of metric of cash flow at the end of the day that's really all the seller has to sell is the cash flow that the business is currently generating i tend to look at things on the buy side on a trailing 12-month basis so right now we're in july so if i were looking at a target company i would typically want to look at at least five years of historical financials and my extensive focus would really be on that last 12 months which would be july 1st of 2021 to june 30th of 2022 and that will give me a real good picture on a rolling 12-month basis what the business is doing you're also going to want to dig into seasonality right i mean depending on what area of the country you're in depending on what area of the world you're in depending on the type of services is a commercial residential there might be some seasonality now unfortunately sometimes it's very difficult to get monthly financial statements from small pest control companies it's it's something that i think is really worthwhile for you doing at least for a two year period at bare minimum you want to at least be able to see the revenue line on a rolling 24 month basis now you've done that work you've gotten a great sense of where the business is on a pre-tax cash flow basis for the trailing 12 months i would recommend that you don't add back depreciation so when you look at the p l often times if an accountant has prepared the financial statements for you they might add back things like depreciation and say something to the effect that depreciation is a non-cash charge right it's a financial or it's an accounting construct and it's used to depreciate fixed assets that we've purchased historically and depreciate them over time i think in pest control you know as a basic rule of thumb depreciation tends to be a really good proxy for maintenance capex and you can never really get to cash flow if you don't run depreciate the depreciation charge through the p l so you take it from the revenue line you go all the way down you get yourself earnings before interest taxes but not depreciation you make sure that charge stays in the p l amortization is typically not something that you're going to really be too focused on for a small pest control company that should be zero or pretty close to nothing now that you've got that cash flow stream what the heck do you do with it as we talked about earlier on in this discussion a lot of guys will will apply a multiple to it four times cash flow five times cash flow and i think it's good for you to understand those multiples but at the end of the day the way that i really focus my attention on looking at this and the way sophisticated private equity firms focus on this is really understanding what the internal rate of return is over a five-year period on a standalone basis now i just said a lot and i know this is confusing if you don't do it every day but here's what i would do again forget that you're taking this business and integrating it into yours you're looking at it on a standalone basis meaning you're going to run it by itself you are going to determine what that cash flow is on a trailing 12-month basis and then you'll project those financial statements out five years so you're going to put together kind of a five-year model on the business on a standalone basis you're going to have five-year historical financial statements that's going to kind of give you a feel for the business but i want you to do those projections because doing the projections i think opens your eyes to a lot of things and really causes you to think about the fundamentals of the business right how is that business going to run standalone what happens to it if the owner disappears what happens do it if key people disappear when you do that sort of analysis it becomes very very easy you can do it on your iphone basically when you look at the cash flow over a five year period you need to determine what your hurdle rate is you need to determine no one else can determine this for you but you need to say to yourself for me to take this risk what sort of a return on the money that i put down do i need to make this acquisition it could be 10 could be 20 percent could be a 30 percent internal rate of return but you need to determine what your hurdle rate is if you use market multiples those are somebody else's hurdle rate you know really what the market's doing on a substitution effect really should not be your concern if you're looking to do a deal purely from a value-creating perspective using your own hard-earned money you project it out five years and then you discount it back and again similar to this we're going to be sending around a very finance a simple financial model in the next month or so that you'll be able to plug these numbers in and calculate your internal rate of return for a private pest control business i would say you definitely want to target a minimum of a 20 internal rate of return probably 20 20 let's call it 25 to 30 percent but you definitely want to be at least in the 20s on that the higher your internal rate of return hurdle the lower the valuation will be once you've determined what that business is worth on a standalone basis now you've got a sense of fair market value and the next step of course is to take that business on a standalone basis and really think about how you are going to integrate that business and how you're going to create value doing 50 to 60 transactions a year for decades having done billions upon billions of dollars in transactions in this space i've gotten to see a thing or two about how companies like anti-c-max and run-a-kill and rollins create value by doing these deals you know the first step when you're doing the merger consequence model is what we talk about when you take the target and you combine it with your business one of the first things you'll notice is they'll likely be some hard synergies and heart synergies tend to be cost savings they might have somebody on the payroll a lot of smaller companies will have somebody on the payroll for 70 years they're no longer productive and they should effectively be terminated so or you might have a full-time person in the office for this small six or seven hundred thousand dollar business and you across town have your own office and you've got five or six people working in there you might not need that person doesn't mean you have to can them right away doesn't mean you have to determine them six months from now but at the end of the day you need to think about how you're going to change the cost structure of that business and so that would be a hard synergies other synergies which i think are very very typical in pest control is what sort of incremental uptick and gross margin you're going to get from combining business a and business b and that's simply you know maybe in that area of town you don't have much density you combine those two businesses and instead of your technician in that area having eight stops a day now he has 12. so you will in effect be much more efficient you're not going to be doing additional revenue there but it'll be more profitable revenue because more of that will flow to the bottom line so that's a route density synergy in addition to route density synergies other typical synergies would be cross-sell opportunities i would say when i look around at a lot of the small add-on or tuck-in acquisitions that the likes of terminex and reticle have done over the years they will typically go out and find you know on the very small end of the market these one and two million dollar businesses that are general pest operations typically residential general pests they may or may not do termite and they likely don't do any other services so what an oregon or a running kill would do is say hey we're going to buy one or two million in revenue in this market we're keeping the officer maybe we'll get rid of the office but nonetheless one of the main things that they do is take that million or two million dollars in residential general pest revenue and then they cross sell services so if your business offers five services let's say you're doing termite you're doing general pest you're also doing mosquito you might have other ancillary services that you've added on or otherwise bundled in you now have the ability to cross-sell those services to that customer base it's very very difficult to project those sorts of synergies unless you have a track record of having done it already meaning you're not going to have any data points to go back and look at you're not going to be able to say over the last 15 acquisitions we've done on average we've been able to cross sell 10 or 15 percent of the customer base so in in the kind of the first iteration of of of analyzing this i wouldn't spend a whole lot of time focusing on the revenue enhancements you can make in the deal there's a variety of other very kind of minor synergies i think when you're talking about smaller deals when big companies do acquisitions i mean they're doing them to either enhance capabilities they're doing them to decrease costs enter into new markets there's some key things that large acquirers are trying to do but smaller firms you're not really many of you won't be getting into new markets i guess it could happen you'll certainly be looking to lower costs through route density and you're probably not necessarily going to be acquiring new capabilities although you may be and a new capability might be you run a general pest control business you don't do termite and there's an acquisition target in your town that does hundred thousand dollars per year in revenue four hundred thousand of that is termite and four hundred thousand dollar that is general pest you've got some great termite technicians over there they're licensed they know what they're doing they've got the experience well if you buy that business now you could take that termite capability and cross-sell termite to your own customer base because you're not doing it now so sometimes those capabilities are acquired but for the most part the extreme majority of the small deals that are done that tend to be you know from let's call it 50 grand in revenue up to about a million by privately held owners tend to be route density plays which is we're going to buy this chunk of revenue we're going to pull it into our routes we're going to keep a few of the technicians we're going to get rid of the back office we're going to close that office down and we will create value by doing the deal so you understand fair market value you understand investment value that the business will be worth more to you than it is the selling shareholders there are ways to model this out and what the big acquirers do is look they've done the same thing you did to determine fair market value they'll take the acquisition target they put together forward projections some acquirers do it five years some do it ten years but they put together these projections going out over time and then they say okay now we've got to draft an investment committee memo and we've got to explain to the investment committee of rent-to-kill or anti-semex why we want to use corporate's money to do this deal and so when we do that we're going to say okay what are the hard synergies we get remove those from the p l what are the revenue enhancements we're getting and the additional cost savings so route density what's that going to do to our p l over time the capabilities that we've bought how we're going to be able to sell more services and get different revenue enhancements and they will actually model this stuff out for you i don't know that i would really get too hung up on that at least on my first acquisition i think as you get more sophisticated and you build a team really the core for you is understanding what fair market value is and then taking control of the process usually when you have small pest control operators and when i say small pest control operators i'm talking about you know again the million dollar less player they call you up you sit down with them you've modeled it out when i talk about taking control of the process my suggestion is you shouldn't sit down with an acquisition target ask them how much they want for their business i think it's very very important from a psychological perspective for you to be in control and for you to anchor a number low so let's take an example let's say there's an eight hundred thousand dollar business and it's running roughly a 20 pre tax cash flow margin so roughly 200 000 on the bottom line and let's say you've modeled it out and you want an internal return of 25 and that implies a four times cash flow deal so very simple 200k on the bottom line uh 25 internal rate return becomes an 800 000 enterprise value that's about where fair market value would fall out for that business and when you make the acquisition offer you know i think it's important to let's say that the fair market value is 800 000 you want to pay less than that and you're willing you've done your modeling and you're willing to pay up to 900 000 for that business well you want to come in and anchor low so i'm not going to be able to tell you right now you know every situation is unique some sellers are more difficult to deal with i mean there's a lot of different unique situations but again you want to be the one that writes that offer a one-page term sheet non-binding and basically anchors that number on the very low end of what you think you can hand to them with a straight face furthermore you know in 2022 the extreme majority of pest control deals are done at between 80 percent cash at the closing to 100 cash the closing and that's probably 95 percent of deals somewhere between 80 percent down and 100 down on smaller deals it's much more realistic to see down payments of of anywhere between 10 and 50 so let's say that you strike a deal at 800k you know it would be reasonable for you to maybe make a two to three hundred thousand dollar down payment and then pay the seller out over a five year period with a seller note um you know i certainly am not giving you legal advice on this discussion you're going to want to talk to a lawyer i would steer clear of any sort of personal guarantees from you you just put together a promissory note it's over five years although i don't really do many transactions anymore that have any contingencies or holdbacks that are contingent upon performance that's very very rare for us as sellside advisors in the industry if i were out buying a target there's no way i would do a deal without making sure that there's some sort of a contingency in there based on future performance so let's pretend the 800 000 business has been doing growing at one percent per year right dramatically less than the rate of inflation and you're going to pay 300 000 up front and 500 000 over time you do want at least for a period of 12 months some sort of a contingency in there that if revenue rolls over or somebody like that the owner or any of the employees go out and solicit customers and begin to impair the value of the business that you've just acquired you want some contingencies in there and contingencies can be very simple i mean and i've seen them done a million different ways you know the big companies like to do what we call taken pays so a customer post-closing would have to take and pay for one service or two services or three services before they're actually deemed a non-cancelling customer if they don't do that then that customer's clawed back from the actual promissory note and you know i think in a subsequent discussion i can go in further depth on that topic but you definitely want to make sure that you have some sort of a clawback provision i often see that folks that don't do a lot of acquisitions can really get mired in the details when it comes to doing an upfront assessment of the business right you want to see tax returns and internal financial statements and all sorts of stuff for me i kind of think it makes a lot more sense to try to get some internal financial statements up front maybe a tax return or two if the seller will give it to you and maybe some exports from festivals pestpac serv suite whatever sort of software the small company is using you know on the front end assessment i think you should be willing and able to maneuver relatively quickly meaning you don't want to spend much time up front assessing the opportunity you want to be very decisive get the materials within a few short days make your assessment come back put a term sheet on the table don't get mired in the details because there's a lot of opportunities out there and unless you really want to build that capability again get the least amount of information from the seller up front that you need in order to make that assessment you have plenty of time in the due diligence period to actually really dig deep into the business and let's say that you put your offer on the table you know the seller is likely to negotiate with you i think one of the things that i would keep in mind if i were you is there are a plethora of opportunities for most people sometimes you live in a really rural area there's only one or two other companies but i think for me personally where we are today in the summer of 2022 it is an absolute horrible time to be a buyer of assets i am selling everything across the board i am selling everything from stocks and equities to real estate everything that i have i am selling just given the fact that the federal reserve is hiking into a downturn this in my opinion is going to be a train wreck in slow motion in the coming years and i of course want to have the resources available to pounce on opportunities so now is really not the time to be buying i think six months from now 12 months from now that'll be a great time to start to really be aggressive on the buy side and you know we'll get through this period over the next kind of six to 12 months where i think the market's going to dramatically change i think that as much as pest control is recession proof or recession resilient yeah it is recession resilient but at the end of the day when the recession does come it really is going to put the strain on a lot of these smaller businesses plus when you add in the stagflationary environment that we have something we haven't seen since the 70s i think it might make for a very very interesting opportunity for folks out there in the industry to go out and pick up these businesses on the cheap because i do know i mean look i've been doing this in pest control since 2003 and in 2008 2009 2010 you know i wasn't even focused on the u.s domestic market during the great financial crisis i mean there was tumbleweed blowing through the m a halls of pest control the large companies weren't buying and the guys who went out there opportunistically like you were able to make an absolute killing i saw people buy businesses doing two million dollars in revenue for four and five hundred thousand dollars i kid you not i saw it with my own eyes so i think those opportunities will be out there if you're patient and you should be very patient as a buyer because your return is set based on the amount of money you pay for the deal i mean it's set when you enter the deal it's your entry multiple be patient um now might be a good time if you really want to take you know advantage of potential great opportunities in the future is really to kind of spend some time thinking about how you're going to model this out spend some time thinking about how you're going to integrate this into your business you know what now in the summer of 2022 into the fall of 22 get out there if you actually wanted to develop a formal acquisition program get out there and spend time meeting with everyone else in the industry in your area and let them know i've got this family-owned business or this is my business here here's how many people i have here's how much we've grown here's what i plan on doing in the industry if you're a privately held pest control business you can really play up the i'm the local guy don't be a sellout because what many many sellers even some of the bigger sophisticated sellers don't understand is there's a huge difference between what a large acquirer can pay not only from a capacity to pay perspective but also the resources that they have in their pocket versus what a local player can pay and sellers often think that price is objective like there's one price for my business so it doesn't matter you know it doesn't matter if i sell to oregon or a small player i'd rather sell to a small player because price is objective it's ludicrous but there's a tremendous opportunity to take advantage i mean look a lot of these big companies out there the private equity firms take advantage of sellers whether they have 500 000 businesses or 50 million dollar businesses when they do not get sophisticated advisors on their side so if you can find an opportunity with a business broker or some you know a seller that doesn't have any really good advice and you might find yourself in a position to get a phenomenal deal and i know sometimes people feel bad about that right it's like you feel bad when you know somebody could have sold something for three million dollars and turned around and sold it for a million dollars but you should not because you're not taking advantage of them you're taking advantage of the opportunity everyone in life has an opportunity to hire advisors who are sophisticated and who could protect them right you get in trouble with the law it's your decision whether or not if you've got the resources to go out and find a fantastic attorney or if you're going to represent yourself in trial so i bring this up because a lot of times you know i'll get calls from clients of ours that might be you know a 50 million dollar firm and they say hey paul i've got this 3 million opportunity and like i think i can get a great price on it i kind of feel bad what this guy's willing to let it go for because he doesn't even number one understand what's going on in the market from a financial perspective he doesn't realize that valuation is subjective and how much should i really push down on this i mean really should i knuckle in and really try to drag him down as far as price goes and i say absolutely this is business you want to anchor low you want to pay as low as you possibly can because guess what at the end of the day if you live in a market society and if you're creating more value for your customers and your more value for your people and more value for yourself you're actually creating value for society as a whole and i almost view it as your duty to take those idle assets out of the hands of non-productive organizations and put them into the hands of your more productive organizations you'll never feel bad about that from a diligence perspective i mean this is when it gets complicated and you know patrick and i on the boardroom buzz have had i think a few discussions historically on of diligence i think we've done some buy-side sessions so you can pull them up but let's say that you've made an offer you've negotiated now you're signing a non-binding letter of intent or term sheet you should give yourself at least 60 days for diligence you know on the buy side if you get an attorney in there who knows what he's doing he's going to try to limit you to 15 or 30 days of exclusivity but really what that means is you sign a term sheet with a seller and you tell the seller hey this is non-binding here's what i think i'm going to pay you i'm going to pay you 800 grand i'm going to give you 300 000 upfront 500 000 over the time over time here's the interest rate and i need to do diligence so you are agreeing for a period of at least 60 days to not have any discussions with any other buyers right so you're you're signing your name next to this you're not going to have any other discussions with any other potential buyers i have exclusive right to look at this business because i'm making investments in the diligence process i might be hiring financial guys i'm hiring legal guys i might hire an environmental guy who knows i'm hiring a lot of advisors i'm spending time money and effort to look at this i want to know that the seller can't go around and shop it fine in addition to the exclusivity clause you need to specifically outline the types of assets that you're actually buying again this isn't legal advice you need to talk to a very competent attorney that has experience in buy-side m a when you do this and a guy that i've known for a long time named mike stanza he's in his 40s there's a lot of guys in this industry that are running around in their 70s and 80s some of these attorneys that tend to do a lot of these deals you know these guys in my opinion stopped being decent 35 years ago so you don't have to hire mike but there are guys like mike who are relatively young who know how to actually use email and word processing programs as opposed to putting notes on stuff handwritten find yourself a good attorney and when you structure your letter of intent you're you're you're choosing typically to do an asset deal or a purchase of assets and again i'm not going to go too into the the legal aspects there are certain times where you would want to do a share deal or a stock deal but for the most part your letter of attempt would effectively say i am buying substantially all the assets of xyz pest control company including but not limited to and then you need to highlight the things that you want right you're buying the customer list you're buying the goodwill you're buying the intellectual property so on and so forth and there's a lot in a letter of intent i'm going to actually go through a letter of intent a few weeks from now to kind of give you guys a better idea or a clearer look on the inside of a letter of intent but once you get that loy locked up now you got yourself 60 days at the 60-day point that's when you really want to get down into the internal financial statements you want at least five years of tax returns on the buzz i can't remember the episode of patrick here he would certainly know it but we talked about getting tax transcripts so if you are a u.s acquirer or rather if the target's u.s the company you're buying is u.s target you can request tax returns directly from the seller but then on top of that you can order a tax transcript from the internal revenue service and i gotta be honest with you there's a lot of times there's material differences not a lot of times i shouldn't say that it's actually rare nowadays but there are times when somebody would report to the irs a million dollars in revenue and actually be doing only 800 000 a year why would they do that they're paying more taxes i get it but with where transaction multiples have been in recent years it makes sense to pay the government more in tax money because the multiple of cash flow and revenue you're going to get is substantially higher than the tax liability so if you could forge that stuff you know you align your pocket so you have to be careful with that so you want to do your tax and accounting due diligence you want to to the extent possible spend time with the people that you'll ultimately be employing in fact if i'm a buyer i want to talk to everyone i want to talk to the guy or the gal working in the office i want to sit down and talk to every technician i effectively want to be able to interview these people and those are the types of things that you should be doing as well clearly you want to do a lien search in certain jurisdictions sometimes liens that exist on the books are actually transferred to buyers so we call that successor liability issues so you're going to want to do a financing statement search again if you've got a good attorney here she'll be able to execute that for you and do the lane search i'm not going to go full deep into diligence because i could spend days talking about the crazy stuff that i've seen and the things for you to look out for what i ultimately wanted to get at here in this whole discussion is number one you're not organ you're not terminix you really need to be extremely conservative number two most of the discussions that i hear from the layman in the industry as to transaction multiples tend to be so don't talk to your buddy who oh i've done a lot of deals i can tell you this that's not really the way to do it if you really want to do it right you're going to have to educate yourself right if you're going to do deals if you're not going to just do a one-off if you're going to get do deals you have to understand in very basic terms how to properly value these businesses and assess your risk you do it you owe it to yourself it's your money when you negotiate with these people and again patrick and i have discussed this on the buzz don't ask a small seller what they want because they're going to give you a number that's dramatically higher than anything you're willing to pay you want to anchor low you want them to negotiate from your low number and up as opposed to hey i've got a 800 000 business i want 3 million now you're negotiating from a 3 million starting point that's not where you want to be you want to be negotiating from a 400 000 starting point and going up versus the other way around and for some people it seems counterintuitive some people were like hey you know maybe the seller won't want that much and if i put an offer on the table maybe it'll be more than he actually wanted for the business i think the chances of that happening are so infinitesimally small that it probably will never happen to you and if it does congratulations um because if you valued it right you're not overpaying for it anyway but i wouldn't worry about offending people you know this is a financial transaction and a lot of times people say you know i was insulted by the offer who gives two shits at the end of the day you're not dealing with your family or your friends you are entering into a financial transaction and you need to make sure that you've measured the risk measure the return and that you're paying the low amount the absolute lowest you possibly can for this business you know i appreciate you tuning in today i will be doing a lot more on the buy set of m a going forward it's something that i spent a lot of time doing you know back in my investment banking years and back when i worked for the largest publicly traded private equity firm in the united states doing buy-side stuff it's not what i do right now because quite frankly it's not as lucrative as doing sell side um but it's something that i do enjoy and i think i can provide a lot of value to you in the industry talking about this stuff so thanks for joining me today subscribe to our potomac tv youtube channel as we're going to be putting a lot of videos on this go ahead and subscribe to the boardroom buzz as well i will be sending out the financial model i don't know what i'm going to get around to it i think once the m environment slows down a little bit this summer i will put together a quick and dirty financial model and i will send it out to our subscribers go to potomacpestcontrol.com subscribe to the commentary and you'll get it again thanks for joining me [Music] [Music] you

[Music] today we are going to talk about buying a pest control business you know here at potomac we do on average of 50 to 60 transactions per year around the globe and i get a lot of questions about the buy side of m a and that's not a service we provide we're largely sell side advisors but often our clients you know we've got hundreds of clients that are in various different stages of the process of ultimately selling their business look to make acquisitions and i get questions every single day about how to value a business how to buy it so that's what i wanted to talk to you a little bit about today you know when i think about buying a pest control business i guess the first thing that pops into my mind is what's your strategy with this what's your goal why would you consider buying one in the first place you know is it an add-on acquisition you're basically filling in density in your current market are you trying to enter into a new market for example buy a business in a separate city to give you a jump start in creating a footprint in a new city there's a million different reasons why you might want to buy a pest control business but i think some of the main problems that i see right out of the gate when folks start to talk about valuation is they frame the evaluation discussion in their mind with what they've heard about what a renai kill or terminax orkin or any of these other big acquirers are doing out in the market and look if you own a pest control business you don't have the same resources as rollins right you don't have the same resources as terminix and quite frankly the value that you can create from a deal is not nearly as much value as these guys can create from a transaction so you have to go in this and be i think extremely conservative when you start to frame up this discussion and we're going to talk about that it's going to be a big part of our discussion today is actually talking about how to value these smaller acquisition targets the other question that i i often pose our clients is are you opportunistic in your acquisition or do you want to develop a formal m a program and here's what i mean by that i think there's a lot of people out there running a business and they get the phone call someone so passed away so-and-so is ill so-and-so wants to retire and there's a five or six hundred thousand dollar pest control business across town do you want to buy it that's the majority of the folks that ask questions are opportunistic right they're in the right place at the right time they have an opportunity to do a deal the other end of that spectrum is growing your business through acquisition which is creating a formal acquisition program creating the capability to go out and source transactions so source deals tying it to a strategy as to how you're going to grow your business and then ultimately execute i'm going to talk a little bit about both of those today but really what i want to focus on right now is where i think most people find themselves which is really in that opportunistic position the first question people often have is okay so how do i even value this and i would typically put the valuation discussion entirely aside get an opportunity to sit down with the seller to understand first off does the business actually tie in to what it is that you're doing i think there's a lot of problems that come up over time when you make an acquisition of a business that might have a very different service frequency it might have some employees there that don't really mesh with the type of business that you run remember a lot of small businesses out there remain small don't create opportunities for their employees and their employees ultimately self-select if you're a young guy and you've got the opportunity to work for a fast-growing company that provides a lot of opportunities or your alternative is to work for a 500 000 business that's not growing at all and it's been around for 30 years i mean there's a lot more excitement working for a large faster growing business so a lot of times those employees self-select meaning they're okay with being in the status quo in that small business so you know the first step is really understanding the motivations of the seller and really assessing the mix between the target business and ultimately your business and and i think some of your front-end work should really be focused on the types of services they're doing right the frequency of services is a company that's largely general pest is it residential is it commercial are you just buying accounts are you actually buying capabilities and and that'll really come into play when we talk about valuation but i think one of the main distinctions you have to make up front is am i buying an actual standalone income producing business or am i just buying a bundle of accounts once you get a sense for what sort of business you're buying and you look at it and say look services make sense i'm going to be able to you know a typical deal like this would increase route density right you've got your service footprint let's say you're doing two million a year find a 500 000 operation that you could tie in the most value creating acquisitions for small acquirers tend to be these density plays so you've got the target company might have gross margins of 50 and that's basically revenue minus direct costs and your business let's say you've got a 60 gross margin and once you combine the two of those businesses you might get an incremental uptick in your own gross margin of maybe 50 or 100 basis points so to you up front it looks like it makes strategic sense you know the next question ultimately comes down to how do you value these businesses and you know a typical valuation metric is a market approach right a transaction multiple we've all heard you know pest control companies tend to sell for x times revenue or x times cash flow um and and there's a myriad of multiples that just get sprayed around the industry i would if i were in your position avoid thinking about things in terms of multiples and actually try to get a little bit more sophisticated as to how you're valuing this business i wouldn't concern myself first off with competition coming in and out paying you know at the end of the day your return is set based upon your purchase price your entry acquisition so you need to be very conservative when you frame up the discussion with the seller and when you think about it from a valuation perspective you really have to look at what is it that i'm buying i'm buying a stream of cash flow into perpetuity and you need to value that stream of cash flow you know in the business valuation arena we talk about standards of value and they're actually quite simple to think through there's two that i want you to continue to have in your mind you have fair market value and you have investment value or otherwise called the strategic value right so there's two of them and the fair market value of a business is what the business is worth to the current shareholders nothing more it's just what is that business worth on a standalone basis and then the investment value or the strategic value i tend to use those interchangeably the investment value of the firm is what that business is actually worth to you the acquirer and typically there's a range usually fair market value will be substantially lower than the investment value and there's what we call a value creation zone in between between the fair market value and the investment value in in any sort of m a transaction the seller wants to sell for as close to investment value as possible and the buyer wants to buy as close to fair market value as possible and so the two goal posts are where a lot of the negotiations take place so what i'll typically tell our clients is look before you start thinking about what the business is worth to you you need to start and think about what the business is actually worth to the selling shareholders i'm having this discussion right now at the end of july 2022. we're in a market that valuations are beginning slowly but surely to roll over and when you think about what goes on in the market it has been a very very busy market the last three or four years even today there's a lot of strategic acquirers private equity firms making acquisitions and they're focused on larger assets so pest control businesses that are less than a million dollars in revenue tend to have less competition from buyers for example rent-a-kill anti-cmx the large strategics in the industry are not spending a lot of time looking at five and six hundred thousand dollar businesses which is great for you because you're unlikely to have competition from the big players secondly the competition that you will have will likely be regionals and other small businesses those guys typically don't have much more experience doing deals than you do so you're not going to really be behind the curve competing with very sophisticated acquirers looking at smaller deals so you know my rule of thumb is i don't care if your business does a million in revenue or 50 million in revenue i think a lot of the value that can be created in these deals by not only getting involved in processes that don't have a lot of competitors a lot of other buyers is these smaller deals really the kind of the eight hundred thousand to three hundred thousand revenue range is a real nice sweet spot for a private acquire when you think about the fair market value of the business it's important to think about you've got the revenue less the direct costs then you subtract the operating costs and you're going to come to some sort of proxy of cash flow we call it and in very basic terms trying to understand what the pre-tax earnings of the business is and it's very common for owners to attempt to add their compensation back into the p l now what i say on the buy side and what i say on the sell side are two very very different things so when you hear me talk about sell side m a i want to throw the kitchen sink back into this but if i'm investing my own hard earned money i'm going to make sure that the p l the income statement that i'm looking at reflects the true costs in the business and you know owners will often times especially for smaller businesses not pay themselves or they might pay pay themselves a very small salary in order to avoid unemployment taxes and and so on and so forth and it's important to really understand from the get-go what sort of economic benefit is the owner actually providing to that business so if the owner is paying himself 30 000 a year um but based on all your knowledge of the industry and what it is that you understand that he's doing after discussion he should be paying himself 85 000 or 90 000 a year you're ultimately going to have to replace that and so once you can effectively normalize a p l and you know over the course of the next couple of months i'm going to provide a financial model for folks in the industry who want to do acquisitions it'll be free you can subscribe to our commentary at potomacpestcontrol.com get yourself on the list and we'll send it around but once you build your model and you normalize the cash flow and you say okay i have attempted to make this p l look like a market deal you're gonna come up with some sort of metric of cash flow at the end of the day that's really all the seller has to sell is the cash flow that the business is currently generating i tend to look at things on the buy side on a trailing 12-month basis so right now we're in july so if i were looking at a target company i would typically want to look at at least five years of historical financials and my extensive focus would really be on that last 12 months which would be july 1st of 2021 to june 30th of 2022 and that will give me a real good picture on a rolling 12-month basis what the business is doing you're also going to want to dig into seasonality right i mean depending on what area of the country you're in depending on what area of the world you're in depending on the type of services is a commercial residential there might be some seasonality now unfortunately sometimes it's very difficult to get monthly financial statements from small pest control companies it's it's something that i think is really worthwhile for you doing at least for a two year period at bare minimum you want to at least be able to see the revenue line on a rolling 24 month basis now you've done that work you've gotten a great sense of where the business is on a pre-tax cash flow basis for the trailing 12 months i would recommend that you don't add back depreciation so when you look at the p l often times if an accountant has prepared the financial statements for you they might add back things like depreciation and say something to the effect that depreciation is a non-cash charge right it's a financial or it's an accounting construct and it's used to depreciate fixed assets that we've purchased historically and depreciate them over time i think in pest control you know as a basic rule of thumb depreciation tends to be a really good proxy for maintenance capex and you can never really get to cash flow if you don't run depreciate the depreciation charge through the p l so you take it from the revenue line you go all the way down you get yourself earnings before interest taxes but not depreciation you make sure that charge stays in the p l amortization is typically not something that you're going to really be too focused on for a small pest control company that should be zero or pretty close to nothing now that you've got that cash flow stream what the heck do you do with it as we talked about earlier on in this discussion a lot of guys will will apply a multiple to it four times cash flow five times cash flow and i think it's good for you to understand those multiples but at the end of the day the way that i really focus my attention on looking at this and the way sophisticated private equity firms focus on this is really understanding what the internal rate of return is over a five-year period on a standalone basis now i just said a lot and i know this is confusing if you don't do it every day but here's what i would do again forget that you're taking this business and integrating it into yours you're looking at it on a standalone basis meaning you're going to run it by itself you are going to determine what that cash flow is on a trailing 12-month basis and then you'll project those financial statements out five years so you're going to put together kind of a five-year model on the business on a standalone basis you're going to have five-year historical financial statements that's going to kind of give you a feel for the business but i want you to do those projections because doing the projections i think opens your eyes to a lot of things and really causes you to think about the fundamentals of the business right how is that business going to run standalone what happens to it if the owner disappears what happens do it if key people disappear when you do that sort of analysis it becomes very very easy you can do it on your iphone basically when you look at the cash flow over a five year period you need to determine what your hurdle rate is you need to determine no one else can determine this for you but you need to say to yourself for me to take this risk what sort of a return on the money that i put down do i need to make this acquisition it could be 10 could be 20 percent could be a 30 percent internal rate of return but you need to determine what your hurdle rate is if you use market multiples those are somebody else's hurdle rate you know really what the market's doing on a substitution effect really should not be your concern if you're looking to do a deal purely from a value-creating perspective using your own hard-earned money you project it out five years and then you discount it back and again similar to this we're going to be sending around a very finance a simple financial model in the next month or so that you'll be able to plug these numbers in and calculate your internal rate of return for a private pest control business i would say you definitely want to target a minimum of a 20 internal rate of return probably 20 20 let's call it 25 to 30 percent but you definitely want to be at least in the 20s on that the higher your internal rate of return hurdle the lower the valuation will be once you've determined what that business is worth on a standalone basis now you've got a sense of fair market value and the next step of course is to take that business on a standalone basis and really think about how you are going to integrate that business and how you're going to create value doing 50 to 60 transactions a year for decades having done billions upon billions of dollars in transactions in this space i've gotten to see a thing or two about how companies like anti-c-max and run-a-kill and rollins create value by doing these deals you know the first step when you're doing the merger consequence model is what we talk about when you take the target and you combine it with your business one of the first things you'll notice is they'll likely be some hard synergies and heart synergies tend to be cost savings they might have somebody on the payroll a lot of smaller companies will have somebody on the payroll for 70 years they're no longer productive and they should effectively be terminated so or you might have a full-time person in the office for this small six or seven hundred thousand dollar business and you across town have your own office and you've got five or six people working in there you might not need that person doesn't mean you have to can them right away doesn't mean you have to determine them six months from now but at the end of the day you need to think about how you're going to change the cost structure of that business and so that would be a hard synergies other synergies which i think are very very typical in pest control is what sort of incremental uptick and gross margin you're going to get from combining business a and business b and that's simply you know maybe in that area of town you don't have much density you combine those two businesses and instead of your technician in that area having eight stops a day now he has 12. so you will in effect be much more efficient you're not going to be doing additional revenue there but it'll be more profitable revenue because more of that will flow to the bottom line so that's a route density synergy in addition to route density synergies other typical synergies would be cross-sell opportunities i would say when i look around at a lot of the small add-on or tuck-in acquisitions that the likes of terminex and reticle have done over the years they will typically go out and find you know on the very small end of the market these one and two million dollar businesses that are general pest operations typically residential general pests they may or may not do termite and they likely don't do any other services so what an oregon or a running kill would do is say hey we're going to buy one or two million in revenue in this market we're keeping the officer maybe we'll get rid of the office but nonetheless one of the main things that they do is take that million or two million dollars in residential general pest revenue and then they cross sell services so if your business offers five services let's say you're doing termite you're doing general pest you're also doing mosquito you might have other ancillary services that you've added on or otherwise bundled in you now have the ability to cross-sell those services to that customer base it's very very difficult to project those sorts of synergies unless you have a track record of having done it already meaning you're not going to have any data points to go back and look at you're not going to be able to say over the last 15 acquisitions we've done on average we've been able to cross sell 10 or 15 percent of the customer base so in in the kind of the first iteration of of of analyzing this i wouldn't spend a whole lot of time focusing on the revenue enhancements you can make in the deal there's a variety of other very kind of minor synergies i think when you're talking about smaller deals when big companies do acquisitions i mean they're doing them to either enhance capabilities they're doing them to decrease costs enter into new markets there's some key things that large acquirers are trying to do but smaller firms you're not really many of you won't be getting into new markets i guess it could happen you'll certainly be looking to lower costs through route density and you're probably not necessarily going to be acquiring new capabilities although you may be and a new capability might be you run a general pest control business you don't do termite and there's an acquisition target in your town that does hundred thousand dollars per year in revenue four hundred thousand of that is termite and four hundred thousand dollar that is general pest you've got some great termite technicians over there they're licensed they know what they're doing they've got the experience well if you buy that business now you could take that termite capability and cross-sell termite to your own customer base because you're not doing it now so sometimes those capabilities are acquired but for the most part the extreme majority of the small deals that are done that tend to be you know from let's call it 50 grand in revenue up to about a million by privately held owners tend to be route density plays which is we're going to buy this chunk of revenue we're going to pull it into our routes we're going to keep a few of the technicians we're going to get rid of the back office we're going to close that office down and we will create value by doing the deal so you understand fair market value you understand investment value that the business will be worth more to you than it is the selling shareholders there are ways to model this out and what the big acquirers do is look they've done the same thing you did to determine fair market value they'll take the acquisition target they put together forward projections some acquirers do it five years some do it ten years but they put together these projections going out over time and then they say okay now we've got to draft an investment committee memo and we've got to explain to the investment committee of rent-to-kill or anti-semex why we want to use corporate's money to do this deal and so when we do that we're going to say okay what are the hard synergies we get remove those from the p l what are the revenue enhancements we're getting and the additional cost savings so route density what's that going to do to our p l over time the capabilities that we've bought how we're going to be able to sell more services and get different revenue enhancements and they will actually model this stuff out for you i don't know that i would really get too hung up on that at least on my first acquisition i think as you get more sophisticated and you build a team really the core for you is understanding what fair market value is and then taking control of the process usually when you have small pest control operators and when i say small pest control operators i'm talking about you know again the million dollar less player they call you up you sit down with them you've modeled it out when i talk about taking control of the process my suggestion is you shouldn't sit down with an acquisition target ask them how much they want for their business i think it's very very important from a psychological perspective for you to be in control and for you to anchor a number low so let's take an example let's say there's an eight hundred thousand dollar business and it's running roughly a 20 pre tax cash flow margin so roughly 200 000 on the bottom line and let's say you've modeled it out and you want an internal return of 25 and that implies a four times cash flow deal so very simple 200k on the bottom line uh 25 internal rate return becomes an 800 000 enterprise value that's about where fair market value would fall out for that business and when you make the acquisition offer you know i think it's important to let's say that the fair market value is 800 000 you want to pay less than that and you're willing you've done your modeling and you're willing to pay up to 900 000 for that business well you want to come in and anchor low so i'm not going to be able to tell you right now you know every situation is unique some sellers are more difficult to deal with i mean there's a lot of different unique situations but again you want to be the one that writes that offer a one-page term sheet non-binding and basically anchors that number on the very low end of what you think you can hand to them with a straight face furthermore you know in 2022 the extreme majority of pest control deals are done at between 80 percent cash at the closing to 100 cash the closing and that's probably 95 percent of deals somewhere between 80 percent down and 100 down on smaller deals it's much more realistic to see down payments of of anywhere between 10 and 50 so let's say that you strike a deal at 800k you know it would be reasonable for you to maybe make a two to three hundred thousand dollar down payment and then pay the seller out over a five year period with a seller note um you know i certainly am not giving you legal advice on this discussion you're going to want to talk to a lawyer i would steer clear of any sort of personal guarantees from you you just put together a promissory note it's over five years although i don't really do many transactions anymore that have any contingencies or holdbacks that are contingent upon performance that's very very rare for us as sellside advisors in the industry if i were out buying a target there's no way i would do a deal without making sure that there's some sort of a contingency in there based on future performance so let's pretend the 800 000 business has been doing growing at one percent per year right dramatically less than the rate of inflation and you're going to pay 300 000 up front and 500 000 over time you do want at least for a period of 12 months some sort of a contingency in there that if revenue rolls over or somebody like that the owner or any of the employees go out and solicit customers and begin to impair the value of the business that you've just acquired you want some contingencies in there and contingencies can be very simple i mean and i've seen them done a million different ways you know the big companies like to do what we call taken pays so a customer post-closing would have to take and pay for one service or two services or three services before they're actually deemed a non-cancelling customer if they don't do that then that customer's clawed back from the actual promissory note and you know i think in a subsequent discussion i can go in further depth on that topic but you definitely want to make sure that you have some sort of a clawback provision i often see that folks that don't do a lot of acquisitions can really get mired in the details when it comes to doing an upfront assessment of the business right you want to see tax returns and internal financial statements and all sorts of stuff for me i kind of think it makes a lot more sense to try to get some internal financial statements up front maybe a tax return or two if the seller will give it to you and maybe some exports from festivals pestpac serv suite whatever sort of software the small company is using you know on the front end assessment i think you should be willing and able to maneuver relatively quickly meaning you don't want to spend much time up front assessing the opportunity you want to be very decisive get the materials within a few short days make your assessment come back put a term sheet on the table don't get mired in the details because there's a lot of opportunities out there and unless you really want to build that capability again get the least amount of information from the seller up front that you need in order to make that assessment you have plenty of time in the due diligence period to actually really dig deep into the business and let's say that you put your offer on the table you know the seller is likely to negotiate with you i think one of the things that i would keep in mind if i were you is there are a plethora of opportunities for most people sometimes you live in a really rural area there's only one or two other companies but i think for me personally where we are today in the summer of 2022 it is an absolute horrible time to be a buyer of assets i am selling everything across the board i am selling everything from stocks and equities to real estate everything that i have i am selling just given the fact that the federal reserve is hiking into a downturn this in my opinion is going to be a train wreck in slow motion in the coming years and i of course want to have the resources available to pounce on opportunities so now is really not the time to be buying i think six months from now 12 months from now that'll be a great time to start to really be aggressive on the buy side and you know we'll get through this period over the next kind of six to 12 months where i think the market's going to dramatically change i think that as much as pest control is recession proof or recession resilient yeah it is recession resilient but at the end of the day when the recession does come it really is going to put the strain on a lot of these smaller businesses plus when you add in the stagflationary environment that we have something we haven't seen since the 70s i think it might make for a very very interesting opportunity for folks out there in the industry to go out and pick up these businesses on the cheap because i do know i mean look i've been doing this in pest control since 2003 and in 2008 2009 2010 you know i wasn't even focused on the u.s domestic market during the great financial crisis i mean there was tumbleweed blowing through the m a halls of pest control the large companies weren't buying and the guys who went out there opportunistically like you were able to make an absolute killing i saw people buy businesses doing two million dollars in revenue for four and five hundred thousand dollars i kid you not i saw it with my own eyes so i think those opportunities will be out there if you're patient and you should be very patient as a buyer because your return is set based on the amount of money you pay for the deal i mean it's set when you enter the deal it's your entry multiple be patient um now might be a good time if you really want to take you know advantage of potential great opportunities in the future is really to kind of spend some time thinking about how you're going to model this out spend some time thinking about how you're going to integrate this into your business you know what now in the summer of 2022 into the fall of 22 get out there if you actually wanted to develop a formal acquisition program get out there and spend time meeting with everyone else in the industry in your area and let them know i've got this family-owned business or this is my business here here's how many people i have here's how much we've grown here's what i plan on doing in the industry if you're a privately held pest control business you can really play up the i'm the local guy don't be a sellout because what many many sellers even some of the bigger sophisticated sellers don't understand is there's a huge difference between what a large acquirer can pay not only from a capacity to pay perspective but also the resources that they have in their pocket versus what a local player can pay and sellers often think that price is objective like there's one price for my business so it doesn't matter you know it doesn't matter if i sell to oregon or a small player i'd rather sell to a small player because price is objective it's ludicrous but there's a tremendous opportunity to take advantage i mean look a lot of these big companies out there the private equity firms take advantage of sellers whether they have 500 000 businesses or 50 million dollar businesses when they do not get sophisticated advisors on their side so if you can find an opportunity with a business broker or some you know a seller that doesn't have any really good advice and you might find yourself in a position to get a phenomenal deal and i know sometimes people feel bad about that right it's like you feel bad when you know somebody could have sold something for three million dollars and turned around and sold it for a million dollars but you should not because you're not taking advantage of them you're taking advantage of the opportunity everyone in life has an opportunity to hire advisors who are sophisticated and who could protect them right you get in trouble with the law it's your decision whether or not if you've got the resources to go out and find a fantastic attorney or if you're going to represent yourself in trial so i bring this up because a lot of times you know i'll get calls from clients of ours that might be you know a 50 million dollar firm and they say hey paul i've got this 3 million opportunity and like i think i can get a great price on it i kind of feel bad what this guy's willing to let it go for because he doesn't even number one understand what's going on in the market from a financial perspective he doesn't realize that valuation is subjective and how much should i really push down on this i mean really should i knuckle in and really try to drag him down as far as price goes and i say absolutely this is business you want to anchor low you want to pay as low as you possibly can because guess what at the end of the day if you live in a market society and if you're creating more value for your customers and your more value for your people and more value for yourself you're actually creating value for society as a whole and i almost view it as your duty to take those idle assets out of the hands of non-productive organizations and put them into the hands of your more productive organizations you'll never feel bad about that from a diligence perspective i mean this is when it gets complicated and you know patrick and i on the boardroom buzz have had i think a few discussions historically on of diligence i think we've done some buy-side sessions so you can pull them up but let's say that you've made an offer you've negotiated now you're signing a non-binding letter of intent or term sheet you should give yourself at least 60 days for diligence you know on the buy side if you get an attorney in there who knows what he's doing he's going to try to limit you to 15 or 30 days of exclusivity but really what that means is you sign a term sheet with a seller and you tell the seller hey this is non-binding here's what i think i'm going to pay you i'm going to pay you 800 grand i'm going to give you 300 000 upfront 500 000 over the time over time here's the interest rate and i need to do diligence so you are agreeing for a period of at least 60 days to not have any discussions with any other buyers right so you're you're signing your name next to this you're not going to have any other discussions with any other potential buyers i have exclusive right to look at this business because i'm making investments in the diligence process i might be hiring financial guys i'm hiring legal guys i might hire an environmental guy who knows i'm hiring a lot of advisors i'm spending time money and effort to look at this i want to know that the seller can't go around and shop it fine in addition to the exclusivity clause you need to specifically outline the types of assets that you're actually buying again this isn't legal advice you need to talk to a very competent attorney that has experience in buy-side m a when you do this and a guy that i've known for a long time named mike stanza he's in his 40s there's a lot of guys in this industry that are running around in their 70s and 80s some of these attorneys that tend to do a lot of these deals you know these guys in my opinion stopped being decent 35 years ago so you don't have to hire mike but there are guys like mike who are relatively young who know how to actually use email and word processing programs as opposed to putting notes on stuff handwritten find yourself a good attorney and when you structure your letter of intent you're you're you're choosing typically to do an asset deal or a purchase of assets and again i'm not going to go too into the the legal aspects there are certain times where you would want to do a share deal or a stock deal but for the most part your letter of attempt would effectively say i am buying substantially all the assets of xyz pest control company including but not limited to and then you need to highlight the things that you want right you're buying the customer list you're buying the goodwill you're buying the intellectual property so on and so forth and there's a lot in a letter of intent i'm going to actually go through a letter of intent a few weeks from now to kind of give you guys a better idea or a clearer look on the inside of a letter of intent but once you get that loy locked up now you got yourself 60 days at the 60-day point that's when you really want to get down into the internal financial statements you want at least five years of tax returns on the buzz i can't remember the episode of patrick here he would certainly know it but we talked about getting tax transcripts so if you are a u.s acquirer or rather if the target's u.s the company you're buying is u.s target you can request tax returns directly from the seller but then on top of that you can order a tax transcript from the internal revenue service and i gotta be honest with you there's a lot of times there's material differences not a lot of times i shouldn't say that it's actually rare nowadays but there are times when somebody would report to the irs a million dollars in revenue and actually be doing only 800 000 a year why would they do that they're paying more taxes i get it but with where transaction multiples have been in recent years it makes sense to pay the government more in tax money because the multiple of cash flow and revenue you're going to get is substantially higher than the tax liability so if you could forge that stuff you know you align your pocket so you have to be careful with that so you want to do your tax and accounting due diligence you want to to the extent possible spend time with the people that you'll ultimately be employing in fact if i'm a buyer i want to talk to everyone i want to talk to the guy or the gal working in the office i want to sit down and talk to every technician i effectively want to be able to interview these people and those are the types of things that you should be doing as well clearly you want to do a lien search in certain jurisdictions sometimes liens that exist on the books are actually transferred to buyers so we call that successor liability issues so you're going to want to do a financing statement search again if you've got a good attorney here she'll be able to execute that for you and do the lane search i'm not going to go full deep into diligence because i could spend days talking about the crazy stuff that i've seen and the things for you to look out for what i ultimately wanted to get at here in this whole discussion is number one you're not organ you're not terminix you really need to be extremely conservative number two most of the discussions that i hear from the layman in the industry as to transaction multiples tend to be  so don't talk to your buddy who oh i've done a lot of deals i can tell you this that's not really the way to do it if you really want to do it right you're going to have to educate yourself right if you're going to do deals if you're not going to just do a one-off if you're going to get do deals you have to understand in very basic terms how to properly value these businesses and assess your risk you do it you owe it to yourself it's your money when you negotiate with these people and again patrick and i have discussed this on the buzz don't ask a small seller what they want because they're going to give you a number that's dramatically higher than anything you're willing to pay you want to anchor low you want them to negotiate from your low number and up as opposed to hey i've got a 800 000 business i want 3 million now you're negotiating from a 3 million starting point that's not where you want to be you want to be negotiating from a 400 000 starting point and going up versus the other way around and for some people it seems counterintuitive some people were like hey you know maybe the seller won't want that much and if i put an offer on the table maybe it'll be more than he actually wanted for the business i think the chances of that happening are so infinitesimally small that it probably will never happen to you and if it does congratulations um because if you valued it right you're not overpaying for it anyway but i wouldn't worry about offending people you know this is a financial transaction and a lot of times people say you know i was insulted by the offer who gives two shits at the end of the day you're not dealing with your family or your friends you are entering into a financial transaction and you need to make sure that you've measured the risk measure the return and that you're paying the low amount the absolute lowest you possibly can for this business you know i appreciate you tuning in today i will be doing a lot more on the buy set of m a going forward it's something that i spent a lot of time doing you know back in my investment banking years and back when i worked for the largest publicly traded private equity firm in the united states doing buy-side stuff it's not what i do right now because quite frankly it's not as lucrative as doing sell side um but it's something that i do enjoy and i think i can provide a lot of value to you in the industry talking about this stuff so thanks for joining me today subscribe to our potomac tv youtube channel as we're going to be putting a lot of videos on this go ahead and subscribe to the boardroom buzz as well i will be sending out the financial model i don't know what i'm going to get around to it i think once the m environment slows down a little bit this summer i will put together a quick and dirty financial model and i will send it out to our subscribers go to potomacpestcontrol.com subscribe to the commentary and you'll get it again thanks for joining me [Music] [Music] you

Transcript for:buy side PE - how to buy a business

Transcript for:
buy side PE - how to buy a business