Corporate Finance in Atlantic Canada

Commentary on corporate finance issues for small- & mid-market private companies in Atlantic Canada

Archive for April 2011

Family business succession can work

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http://www.financialpost.com/executive/best-managed/pass+your+business+keep+family/4691008/story.html 

We all know the stats about how roughly 10% of family businesses make the transition to the third generation … so when one does, it is a nice success story to hear.  Click the link above to read about PolyCello in Amherst, NS.  Congrats to the Emmerson family and all of the employees of PolyCello!

Written by Dan Jennings

April 29, 2011 at 4:17 pm

Posted in CF Musings

Andy’s Tire sells to local buyer

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http://www.ns.dailybusinessbuzz.ca/Provincial-News/2011-04-27/article-2457785/NS%3A-New-owner-of-tire-company-sees-potential-for-growth/1?newsletterid=203&date=2011-04-27-06 

Some of you may have seen this news about multi-location tire retailer, Andys Tire, selling to Truro entrepreneur Garry Pye.  An interesting transaction in that owner Mike Langille sold to a local financial buyer rather than a strategic acquiror, but Mike sounds very happy.  Garry is a well-known entrepreneur in a number of industries, but based in the car dealership sector.  Congratulations to both the seller and buyer!

Written by Dan Jennings

April 27, 2011 at 11:31 am

What’s your number?

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http://www.capitalmagazine.ca/plan/business-valuation-and-multiples/value-proposition-2-1092 

The link above is an interesting article in the new Canadian Capital magazine on the topic of how entrepreneurs arrive at the expected selling price of their businesses.  “How many zeroes would the cheque need to have for you not to show up for work tomorrow?”

A tough part of my job is sometimes telling an entrepreneur that the business that he & his family have built and operated for years may not be worth what he thinks it is, or it may not be worth what he needs in retirement to fund a certain lifestyle.  This can make for some very rough meetings … and this is not some accountant producing a spreadsheet that says the business is worth 5x earnings!  This is after we do our extensive research to show the entrepreneur how & why the market will price the business.

What these meetings illustrate for me is that some small and mid-market entrepreneurs don’t plan for their eventual exit from their businesses and are then surprised about how the market perceives value in their businesses.  If you plan for retirement in advance, you’ll recognize the signs that the market may or may not appreciate all the things about your business that you believe are great  … and more importantly, if you have some time in advance of your retirement, you’ll be able to use value enhancement tools in order to increase the value of your business.

So, before deciding on “What’s your number?”, get some professional valuation advice … and not just a quick & dirty valuation, but rather an indepth analysis of the potential selling price of your business in your industry in today’s M&A marketplace.

Written by Dan Jennings

April 26, 2011 at 11:18 am

Posted in CF Musings

The 2 levels of value (part 3 – a specific example)

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I wrote last time on the two levels of value in a business — financial/standalone value and a higher strategic value (obtainable from large industry buyers).

Nowhere is this concept more relevant than the insurance broker industry.  M&A pricing for insurance brokers is commonly quoted as a multiple of annual commission revenue (2-4 times is tossed around these days).  Such rules of thumb (particularly based on revenue) are speculated on because they are easy to understand and apply, i.e. anyone can determine annual revenue and multiply it.  However, the 2-4x multiples being quoted today for insurance brokers are driven by the second level of value, i.e. strategic buyers who are consolidating the industry.  Insurers themselves (such as Intact) or insurer-owned brokers (such as Johnsons) are paying the higher strategic values because they are synergistic buyers, i.e. they bring synergies (like removing the broker commission altogether) that allow them to pay the higher price.

Now, when I’m helping the owner of an insurance brokerage sell, I run an auction process around getting those strategic buyers to pay a potentially even higher multiple.  But when the owner wants to sell his/her brokerage to family and/or employees, things in this industry get complicated.  Unless the family or employee buyers can access synergies, those kinds of buyers simply cannot afford to pay prices of 2-4x revenue (since those buyers are using the cash flow of the existing business to debt finance the acquisition, along with some of their own equity and perhaps some vendor financing).  Simply put, those buyers don’t have operating synergies (because they don’t have other operations to combine the acquired business with).  But, and this is relatively unique to the insurance broker industry, many of the insurers (including the acquirers above) will help finance a family/employee succession with preferred debt financing terms.  This financing may not allow a family/employee owner to fully makeup for the lack of synergies of the strategic buyers, but does allow them to at least compete for acquisitions.

So, in this industry, the two levels of value (as well as the industry rule of thumb) are very real in the M&A marketplace.  If anyone tells you they priced an insurance broker based on 5x cash flow … they may have misread the entire industry!

Written by Dan Jennings

April 13, 2011 at 1:16 pm

Posted in CF Musings

The 2 levels of value (part 2)

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I wrote last week on the fact that many entrepreneurs don’t realize there are 2 levels of value in many businesses:  a financial or standalone value, and a strategic value.  Financial buyers, such as existing management or external buyers not already in your business, can pay the former, while large industry buyers may be prepared to pay the latter.

The first challenge, particularly for small businesses, is that there aren’t strategic/industry buyers interested in your business.  This is a real issue when I research the market for some small businesses in our region.  In order to achieve a strategic premium price, I attempt to create a situation where multiple strategic buyers are seriously interested in acquiring your business, but the reality is that for many small businesses (across a variety of industries), there are no such buyers, and therefore, I can’t get a financial buyer to pay more than a financial/standalone price. 

Mind you, financial/standalone value may be a fair price … but it’s not likely to be a premium price.  This is why you see many local buyers paying fair market value based on notional valuations that use standalone cash flows.  Unfortunately, there are plenty of businesses in our region that can only attract this level of value.

Second, and this goes back to an earlier post of mine, the best way to get premium price offers for your business is to use an auction (or modified auction) process, i.e. it is my job to establish a confidential sale process (including guiding the flow of information) so that ‘competitive tension’ amongst the buyers entices from them their best possible offers as to price and terms.  Buyers may not like it, but creating competitive tension such that they pay a higher price or better terms is my job in a sale process.  Too often, I see entrepreneurs negotiating with one potential buyer at a time.  Even if they negotiate what they believe is a great deal, how do they KNOW it is the best possible deal they could have gotten?

Finally, even if there are no strategic buyers willing to pay a premium price, I still use a modified auction process to achieve a maximum standalone price.  That’s because the competitive tension forces buyers (even financial/standalone buyers) to put forward their best offer.

Written by Dan Jennings

April 12, 2011 at 9:49 am

Posted in CF Musings

The Masters …

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Not corporate finance, but … another April weekend of watching the Masters!  The international players made for another great Sunday of back nine roars.

Why is it that the TV announcers don’t talk about how much luck plays a part in winning a major?!  Schwartzel played a great round, especially 15 through 18, but the somewhat ‘lucky’ shots on 1 and 3 started it.

Written by Dan Jennings

April 10, 2011 at 10:56 pm

Posted in Uncategorized

The 2 levels of value (part 1)

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I regularly speak to clients (and potential clients) on the two levels of value that often exist for a business.

The first is called financial (or standalone) value, which represents what a reasonable investor would pay for the future expected stream of cash flow from your business.  Because this uses existing cash flows, it is sometimes called standalone value, i.e. the prospective buyer is someone who isn’t currently in your industry and is buying your business because of its future profits as a standalone business.  You may have seen traditional (or “notional”) valuations that estimate financial value using a variety of approaches focused on expected cash flow and capitalization rates (or multiples).  Capitalized Cash Flow (“CCF”) is one such approach, while EBITDA Multiples is another.

The second level of value (and one that I commonly see advisors not focusing on) is the potentially higher price that a strategic (or industry) buyer might be willing to pay in certain circumstances, i.e. strategic value.  If a prospective buyer of your business already operates in your (or similar) industry, that buyer has access to synergies (such as cost savings or margin improvements) that potentially allow it to pay a higher price than financial/standalone buyers (because financial buyers don’t have access to such synergies).  Strategic buyers are often much larger companies that may be consolidating an industry, and their size often gives them an additional synergy of being able to access capital more easily (and less expensive) than financial buyers.  This latter synergy is particularly true for public companies.

While strategic value is more difficult to estimate in advance of actual negotiations (because you don’t know the buyer’s operations, so you don’t know the exact nature of synergies), we have developed proxies that allow us to illustrate ranges of possible strategic value.  These proxies consist of estimating a portion of synergies and/or estimating the cost of capital for strategic buyers, combined with research into whether such buyers could be interested in strategic acquisitions.

The challenges are first, not all businesses have strategic buyers interested in them, and second, running a sale process that is designed to motivate such buyers to pay a premium price.  Stay tuned for Part 2, where I’ll go into more details on these challenges.

Written by Dan Jennings

April 6, 2011 at 12:13 am

Posted in CF Musings