Going slightly M.A.D.

Jim Huston

A number of years ago, a $1 million commercial lawn maintenance contractor in Colorado called me. He was interested in possibly selling his business. His net profit margin after all bills and a reasonable salary to him were paid was 10 percent. I gave him a ballpark value of around $0.75 per revenue dollar – $750,000.

This figure included his equipment, inventory at fair market value (FMV) but no real estate. He then told me that his CPA, using various evaluation models, told him he should get around $2 million for his business. “Gee!” I said to him, “This makes me look stupid, doesn’t it?” However, I then went on to tell him that he had better get all of his money, the entire $2 million, up front. Otherwise, he’d never see it, but I’ll get to that later.

The point is that mergers and acquisitions take a lot of work, but can also be a great boost to your bottom line. Many companies in the U.S. and Canada are growing their revenue in the current economy by means of mergers and acquisitions. You get M.A.D. when you add sellers to this equation (divestitures). Donald Trump’s 2004 best seller, The Art of the Deal, recognizes an important aspect of a deal. It is as much art as it is arithmetic.

The current trend in such deals focuses primarily on the somewhat constant revenue streams of the maintenance and service sectors. M.A.D. transactions involving construction revenue streams are not common, but do happen. The buyer is betting that future revenue streams and profits generated from the purchased book of business will more than offset its price. This is often the case but even the big boys, the large consolidators, get burned now and then.
 

The process. You need to assemble a team of professionals to assist you in any transaction. First, you need a good attorney, who specializes in such matters. This person should review correspondence; contracts; non-compete, confidentiality and non-disclosure documents; to name a few.

Second, you need a certified public accountant (CPA) who is familiar with buying and selling companies. He or she will evaluate the tax and financial implications of a deal. A business broker may also be involved but beware, such a broker is often a real estate broker who “brokers” businesses – any business.

Green industry businesses have their unique aspects and a generic evaluation approach can be detrimental. You may want to involve a consultant who is familiar with such deals within the green industry. While not a broker, this person can coach you through the M.A.D. process.

Placing a value. Once you have your team assembled and have identified a potential M.A.D. target, you then need to evaluate the target business. There are basically two models commonly used for doing so. I evaluate a company or book of business using two models when determining value. This value is what is commonly called “blue sky” or “goodwill” and it excludes hard assets such as equipment, inventory and real estate. Combining the two provides a larger perspective or “value parameters,” so to speak. You could call it a value range or grid.

While value, like beauty, may be somewhat in the eye of the beholder, there are limits. FMV is what a willing buyer will pay a willing seller in a free market. How much a willing buyer will pay is often anybody’s guess.

On the other hand, evaluation models, trends and industry benchmarks can be helpful, but they must be considered within the greater context of what motivates the buyer or seller to pursue such a deal.

Without doing so, you could miss an opportunity or leave a lot of cash on the table.

GPM Model. Many buyers are willing to pay one year’s worth of gross profit for a book of maintenance or service business. To see the formula for GPM visit www.lawnandlandscape.com and search “Huston GPM.”

The EBITDA Model. EBIDTA is an acronym for earnings before interest, taxes, depreciation, and amortization. This model is generally used for larger, multi-million dollar deals and/or public stock offerings.

Except for highly profitable companies, ones with net profit margins (NPM) exceeding 15 percent, the EBIDTA evaluation results are very similar to the GPM model.

How it works. So, remember my client from the beginning of this column. Think about this deal. Even if a buyer pays $1 million as a down payment, and the seller finances the remaining $1 million for ten years at 10 percent interest, the interest payment wipes out the entire net profit margin for ten years.

There’s nothing left to pay off the principal. This deal simply will not work. This is not Monopoly. There are parameters for these deals.

A highly profitable maintenance company (NPM over 20 percent for many years) with annual revenues exceeding $7 million, calculated a value for his business of about $2.45 million using the GPM model.

I recommended that he and his CPA use the EBIDTA method. Using it, the value calculated to be roughly $5 million, double the GPM amount. In the final analysis, he used the EBIDTA model and sold his business for over $5 million.

Conclusion. As Trump says, determining value is as much art as it is mathematics. You must do your homework – due diligence – but don’t get lost in the numbers. Value is determined as much by the buyer or seller’s motivation to do a deal as it is by the numbers.

Remember, before you attempt to do a deal, assemble a M.A.D. team that will provide essential counsel regarding any transaction. Going M.A.D. can be a tool to help you grow.

Or, if pursued rashly, it can result in a “shotgun wedding” where you spend what seems like an eternity with Roseanne Barr as a mother-in-law. I wouldn’t wish that on anybody.

To see Huston’s benchmark evaluation chart, visit www.lawnandlandscape.com and search “Huston benchmark.”