SELLING A CONTRACTING BUSINESS

It took over a year, but we sold the contracting business in Phoenix. Every seven-figure transaction is going to have some hiccups, and this was no exception. One of my frustrations is the lack of assistance available from banks and the SBA.

A traditional bank loan involved an acquisition portion (longer term, amortized) and a working capital portion (a revolving credit that would go up and down, interest only, based on the value of inventory and accounts receivable). Those are just not available anymore.

There is a terrific opportunity for people in the lending business to take over that role, by the way.

Back to the transaction. My role is to clearly and accurately describe the financial results and the way the business operates to prospective buyers. I need to also describe the financial and other requirements of any buyer which, in the real world, means discouraging a lot of people.

Financial institutions and a lot of brokers do not fully understand the contracting business, and it is essential to have a working knowledge of the lingo and the details. Items like retention, bonding, pay-when-paid, AIA billing and so on. All are terrifically significant.

When the drive to the finish line starts, it is my responsibility to keep all the parts in motion, and particularly to get the financing locked in place.

Thankfully, the buyer and the seller in this instance were reasonable people and we got the deal done with a minimum of fuss.

Thanks to all involved.

THE MYTH OF THE BABY BOOM SELLERS

Written much more elegantly than I could ever do, this author (first published on Axial Forum and many thanks for granting me permission) discusses what we expected to happen (lots of Baby Boom sellers) and what actually happened (they couldn't afford to sell).

The truth is that Buyers can only afford to pay "x" amount, and that has to do with the income produced by the business for sale. If it is small, the amount of cash produced by the business required to take care of a fair wage ends up being a big chunk of the cash produced leaving only a small portion to pay for the business. Just facts.

I have an acquaintance, maybe a client some day, who might be the poster child for Mr. Robert Flynn's essay. He had a successful distribution business for many years, sold off (more like, gave away) big chunks of it to some of the people who had helped him make it successful and partially retired. He now collects $125,000 to $150,000 per year with two employees and he just checks in daily and spends a good amount of time on the serious business of being retired. Everything is done over the internet and he provides really good jobs for his employees. Why sell for $200,000 when he has that arrangement?

Where Are All the Baby Boomer Sellers?

By Robert Flynn, United Business Brokers, LLC | December 9, 2015 Originally published on Axial Forum

Various exit planning forecasts predicted that between 4.5 to 17 million small businesses would hit the market for sale in 2012-2018 period — thanks to baby boomers approaching retirement and taking steps to sell their business before the next downturn in the economic cycle. The 2013-2015 period was projected to be the peak of the baby boomer selling boom.

But business for sale listings (mostly “Main Street” and often with less than $500,000 annual revenues) on the major transaction sites, as well as the middle market business brokerage firm listings are down in almost every Northeast state we track compared to five years ago.

So where are all the sellers?

Our conclusion is that many of the basic market assumptions of the exit planning industry are wrong.
Not all small businesses are big enough to be crucial to fund retirement. US Census Bureau and SBA statistics for small businesses note that 85% have less than nine employees and 95% of such companies have four or less employees. Of these businesses, 53% had less than $500,000 in annual revenues with 28% reporting less than $100,000.

These asset thin businesses are frequently service related or retail business models which generate possibly $60,000-$100,000 in adjusted owners’ earnings. Such businesses generally sell not at the listing ad earnings multiple but in a range of 1.5-2 X adjusted owners’ earnings — which after payment of commissions, closing costs, and other obligations leaves little for retirement.

For entities with over $2 million in annual revenues, and certainly for those with over $4 million in annual revenues, the business sale is a central component to retirement planning and sophisticated planning is required. But for probably 95% of all small businesses in the United States this is not the case.  Estimates of the small business population in the United States vary, but a mid range of 28 million small businesses probably yields a total available exit planning market potential of 1,500,000 businesses, which after adjustments for normal attrition may yield 500,000-600,000 businesses which are prospects for formal exit planning. We estimate that many professional exit planners have apparently greatly overstated the quantity of businesses which will be sold for retirement purposes by a factor of 9 to 15 times.

Most small businesses generate cash flow for an owner and his or her family for some period of years and then quietly close. In other cases, the owner creates an internal solution such as a sale to an employee or family member.

Such businesses unfortunately have little value as a store of wealth and a platform for a financially stable retirement. They often provide livable compensation for the owner and a handful of employees for just a few years: the SBA reports that only one-third of small business formations exist after ten years. Exit planners seem to overlook this fact and assume that all existing businesses will transition into the retirement age of the owner.

Other thriving business owners are postponing selling their business to take advantage of possibly the last two to three years of growth in their local economy and business. Many small business owners suffered through the recession in 2008-2010 and want to harvest a few more good years. They will sell — but it will likely be at the wrong time and for a depressed valuation.

The traditional retirement period is also being pushed out as people live longer. The prospect of retirement is less and less attractive to many owners, who are still vibrant and capable of running their companies.

We predict that there will be approximately one-half million small businesses with sophisticated exit planning needs over the next five to ten years which might be marketed for sale — many fewer than the widely projected 4.5 to 17 million that would be marketed for sale and not substantially higher from historical listing levels.

We also believe that there will not be a major imbalance between sellers and buyers.  The historical assumption of one buyer for one seller is dead as a new pattern of consolidators and investors has emerged who acquire 2-10 (or more) businesses.


The exit planning industry is correct that a multi-disciplined strategy is needed to evaluate, select, and execute a strategy to sell a small business, especially if the revenues are $2 million or more. We recommend that business owners looking to sell obtain an independent third-party business valuation. Inflated valuations add time to the process and put the seller at a disadvantage, especially if marketing the business in a declining valuation market.

Insider Trading, Construction Company

Insider Trading (Buying a Construction Company)

I wrote an article on BizQuest a while ago, and the response has been gratifying. Apparently others have conversations with their spouses that end with, “You should try to make more money… Dear.” I think they go to a special school someplace to learn how to say “Dear” and “Fine.”

INSIDERS

The clients generated from the article tend to be “Insiders” and have these general characteristics:

• Construction professionals, so they know the business
• Have a structure in mind
• Buying from their boss or the family
• NEED HELP WITH THE FINE POINTS OF THE BUSINESS DEAL

CONSULTING

For years I have resisted retainers and relied on success fees. It just makes me feel better when my compensation is based on getting something done. Plus, just about all of my serious negotiations have included a money-back guarantee—if you decide that I did not do what I said I would do, you get your money back.

If you are an insider buying a construction company, you need a limited service. It is not fair to pay me a percentage of the deal. You just want some advice and help about the deal points, and it is not legal or accounting advice. Nor is it advice about the construction business—you already know that.

WHAT IS A FAIR PRICE FOR THAT SERVICE?

As Shakespeare wrote, “Aye, there’s the rub.” But I think I have it figured out if we follow this guideline—You will be happy with the fee. Let us start with that motto and go from there. If my advice is worth “not much,” the fee should be commensurate.

So, here is what I propose: let me give you some thoughts, a Confidentiality Agreement and perhaps an example. No charge for a review of the existing financials and the existing Letter of Intent or whatever you have. I will let you know what I think needs to be done and an estimated cost, and my daily fee is $1,500 per day. You decide how to move forward, and we will part with favorable mutual respect. I guarantee it.

It Happened Again

Friday, it happened again. The call that I get maybe once or twice a year. Each time, I'm flabbergasted (you don't get a chance to use that word much, so had to do it). Here is NOT an exact transcript, but close:

Caller: I'm interested in your listing.

Me: Uh, which one?

Caller: The one that looks like the guy is working only part time.

Me: (Guessing) Oh, you mean the one in St. Louis??

Caller: Yes.

Me: (I tell him a bit about the business, why it is for sale, nothing confidential. He asks for a Non Disclosure Agreement, everything is going along well.) Can you tell me a bit about yourself?

Caller: (Youngish, some money, good job. Married. Wife employed. Get ready for the punch line.) And, so, I just want to get something cheap that I can spend a little time on, part time, not in the evening or weekends, and make a lot of money.

Me: (There was more to it than this.) Good luck.

The first time I heard this reason for owning a business, it really surprised me. A lady came into my office in Kansas City, appeared to be in her early 40's and told me that she had about $50,000 and wanted to buy a business that would pay her "around $100k per year." I told her that was a tall order for a small investment. She said she could settle for less, but what she really wanted was a business... so she could spend Fridays and Mondays at the Lakes. Like that was the rule if you owned a business!

Unfortunately, small business owners, the heart and backbone of America in my opinion, are among the hardest working people I know. They often make really good money, but they also pay attention to their businesses and that sometimes means long hours.

They are devoted to their families, their employees and their customers. They are not in it for "four days at the Lakes." When the income arrives, it is often after several years of effort--but then, the executive who is making good money at a large company has spent several years earning into that job, too.

The small business owners I deal with every day are good people, with justifiable satisfaction for the place they have carved out in this world. They enjoy their work and the experience, and they also enjoy freedom, accomplishment, knowledge that there is nobody else to blame and better financial rewards (not all at once) than they would receive working by the hour.

But it is not for everyone. Obviously.

Why own a small business?

 

This article exposes the unpredictability and the lack of reason that accompanies Wall Street and, by extension, passive investing in general. Check out the full article by Jeff Cox, a finance editor at CNBC.

http://www.nbcnews.com/business/markets/10-insane-things-wall-street-really-believes-n233241

The gist of the story is that while we may have been told by various sources that the markets, particularly the financial markets, are efficient--yeah, not so much. We can go into a defense of the markets as the best thing we have, which is true, but that mechanism is often derailed by emotion.

When I was first involved in the financial business, I was told that there are only two emotions in the markets, fear and greed. Sometimes one wins, sometimes the other. The classic bull/bear. We read "analysts" telling us how the price of a stock is this or that based on, well, this or that. Others consult their Ouija board of charts and based upon those charts (and I suppose a few tea leaves), make predictions as to when and how much.

Below is the list of Ten Insane Things Wall Street Really Believes.

1. Falling gas and home heating prices are a bad thing.
2. Layoffs are great news, the more the better.
3. Billionaires from Greenwich, Connecticut, can understand the customers of JC Penney, Olive Garden, Kmart and Sears.
4. A company is plagued by the fact that it holds over $100 billion in cash.
5. Some companies have to earn a specific profit—to the penny—every quarter but others shouldn't dare even think about profits.
6. Wars, weather, fashion trends and elections can be reliably predicted.
7. It's reasonable for the value of a business to fluctuate by 5 to 10 percent within every eight-hour period.
8. It's possible to guess the amount of people who will get or lose a job each month in a nation of 300 million.
9. The person who leads a company is worth 400 times more than the average person who works there.
10. A company selling 10 million cars a year is worth $50 billion, but another company selling 40,000 cars a year is worth $30 billion because it's growing faster.

Yogi had it right. Predictions are hard, especially when you're talking about the future. Just discovered, via the Google machine, that this sentiment has been attributed as well to Niels Bohr talking about quantum mechanics. Too bad it appears to be apocryphal because it says a lot.

Shameless promotion: I can help you find that ideal small business. Give me a shout at info@nbbcompany.com

Example

OK, I'm going to be the first to admit this is not riveting prose. Take a look, though. Gives you a sense of what I do when the assignment is consulting rather than selling/broker stuff.

MEMORANDUM

To:        Client
From:    Bob Peterson
CC:      
Date:     March 19, 2014
Re:        Valuation

In your email of March 18, you described the current situation and asked me to review a couple of the terms of the current agreement and to give you some language that may be appropriate for a "valuation" of the enterprise at some point in the future.

You and I agreed that such a provision should be acceptable to both parties, as simple as it could be and that it should not jeopardize the arrangement under consideration by the parties.

The Parties, as I understand it

1. Your Company, (YC) 100% owned by Client and formed exclusively to own 25% of the operating enterprise
2. Operating Company is the operating enterprise formed for the purpose of completing projects developed and financed by the 65% owner, Mr. Seller, 10% by another party and 25% by YC. Operating Company will operate as a commercial general contractor pursuant to an Operating Agreement.
3. Client will be the COO of Operating Company, salary $200,000 plus benefits as agreed and responsible for complete oversight of all commercial construction operations.
   The Deal
4. All projects developed by Seller will be built by Operating Company.
5. Profits will be divided as per ownership, pro-rata; tax distributions will be estimated by a CPA or other qualified tax advisor and any distributions in excess of tax distributions will be considered return of capital or liquidation proceeds and accounted for separately.
6. YC has the option to withdraw cash from Operating Company when cash accumulated exceeds $1 million.
7. No costs, charges, allocations, depreciation or other similar charges not directly related to the activities of Operating Company or the projects will be made against Operating Company.
8. Only project management software approved by YC, at its sole discretion, will be used to capture, track and confirm all costs, margins and profits associated with Operating Company and its projects.
9. YC will retain the right to authorize any withdrawals from Operating Company bank and similar cash accounts.
10. Profits will be allocated to the Members according to their unit ownership, tax distributions will be made pro-rata as will any distributions in excess of tax distributions.
11. Any member will have the right to audit the results and the recordkeeping of Operating Company at reasonable intervals.

Buyout, Valuation, Termination Overview

Investors from Benjamin Graham to Warren Buffett agree that "In the long run, Earnings Determine Market Price." They also acknowledge that "In the short run, Emotions Determine Market Price." They were talking about publicly traded stocks, but the same principle applies to small companies that I have been working with for over 20 years, just the fine points are different.

Earnings

The first thing to determine in the valuation process is Earnings. In this situation, the best measure of the earnings is, in my opinion, Earnings Before Interest, Taxes, Depreciation and Amortization computed on an accrual basis (EBITDA).

You or the majority holder could manipulate earnings to an advantage if computed on a cash basis. In a construction company, these earnings will need to account for earnings on uncompleted projects based on a percentage completion basis. For tax purposes, you may delay billing or you may lay in a large stock of material and this should not be used to manipulate valuation as it might be with the cash basis method of accounting.

When dealing with partially complete projects, the Agreement should employ a “look back” provision to adjust estimates to actual.

Cash

When "cash" is referenced in this memo, it means liquid assets, not other current assets like inventory. Cash should be dealt with separately in any valuation process inasmuch as it is not reasonable to pay a multiple of cash. If there is substantial inventory that is not specifically allocated to projects, that should also be dealt with separately, usually at cost.

EBITDA

EBITDA in this context should not be affected by one-time or extraordinary impacts on earnings and should be calculated according to GAAP before distributions.

Fair and Equitable Process to Value a Construction Company

At termination or a wrapping up of Operating Company or of YC's involvement and ownership interest in Operating Company, the enterprise will be valued as follows:

VALUATION METHOD ONE: MULTIPLE OF EBITDA PLUS CASH 

1. Total Valuation of Operating Company shall be determined after customary estimated tax payments are calculated by a qualified tax advisor and made on behalf of the Members;
2. Earnings for projects not yet completed shall be valued on a percentage of completion basis. Holdbacks or retention will be discounted at an annual rate of 10%;
3. Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) shall be calculated according to Generally Accepted Accounting Practices (GAAP) before extraordinary or unusual charges/income and on an accrual basis as of the twelve months ending at the date of Termination.
4. The value of Operating Company shall be the sum of:
   1. Two times EBITDA as described herein PLUS;
   2. Cash and liquid assets NOT including inventory, after tax provisions and after taking into account and returning any cash contributions made by the members;
5. YC's share of the Total Valuation of Operating Company as determined by its then-current membership shares as a percentage of total ownership shares shall then be paid to YC in cash or other terms as determined by YC at its sole discretion.
6. In the case of partially completed projects, a reasonable amount of the Purchase Price shall be escrowed and a “look back” provision shall be employed to determine at a later time, say three or six months hence, depending on the contract characteristics, the actual versus estimated value of those contracts.

VALUATION METHOD TWO: ARBITRARY, PRESET VALUATION

This method takes the "valuation" issue off the table; the value has been preset at the salary plus benefits (converted to cash) of the COO plus the pro-rata share of the cash earned and retained.

1. The purchase price of the Membership Units would be set at salary plus benefits, say $275,000.
2. In addition, the cash (earnings retained in the company in the form of cash and similar instruments) after consideration of contributed organizational cash and any subsequent contributions from Members and after consideration of any distributions in excess of tax distributions would be distributed pro-rata. Any capital contributed by YC shall be returned dollar for dollar. 

OTHER VALUATION METHODOLOGIES

Different methodologies are appropriate for different businesses. It is the opinion of NBB that none of the other valuation methods can be appropriately used to value a construction company such as the one described to us.

Having said that, should a construction company nearly identical to the one described herein in terms of size, location, quality and quantity of projects, structure and customers were to be found with a sale within a year, that comparable would be the best indicator of value.

Respectfully presented,

Bob Peterson

Principal

Honey, I Just Talked to Divorce Lawyers

Valuing a Construction Company
Or Honey, I just talked to divorce lawyers.

By Bob Peterson | National Business Brokers Company

The other day, I walked into my wife's office and said, "Honey, I just talked to a divorce lawyer."

"Oh?" With raised eyebrows. Way to go, I had her attention!

"An old listing has asked me to provide a value for her construction company in a divorce case and I have agreed to do it." "Oh." The attention was fading. Quickly.

Agreeing to provide a valuation, a deposition and testimony in court for a small fee and a potential listing did not raise my total worth in her eyes; and when I blurted it out, it didn't sound like a brilliant idea to me either.

Subjecting yourself to the humiliation and aggravation of interrogation by a lawyer set to make you look and sound incompetent should be avoided. So why do we do it? The only real reason: I know what a construction company is worth on the market, how difficult it is to find a buyer and close a transaction and I am offended by the highly paid, sublimely degreed imbeciles who compare the value of a construction company to a window manufacturing and installation business in Tampa.

The truth needs to be told. My wife, however, thought maybe someone else should tell it, and I should devote my efforts to something more productive and profitable. She had a point.

If you approach this from a mathematical viewpoint, develop averages, weighted averages and the like, the results are, in my opinion, flawed and extremely inaccurate. In this case, I thought the opinion of the opposing expert that the value was $750,000 was heinously wrong, but these types of valuations are appealing to the court because they do not require "judgment."

My opinion of value was $250,000 and I told her she would be lucky to get it. Especially since she was unwilling to provide a non-compete.

Here is what I subtracted from the "mathematical" viewpoint:

1.     The lack of a non-compete. In this very personal business, the cooperation of the Seller is critical, and, in this case absent.

2.     There was a back charge pending for over $300,000 and retainage exceeded $600,000. My valuation assumed (properly, I think) that only a fraction of these would be collected by a new owner.

3.     Backlog at the time of valuation was $300,000. Compared to annual revenue of $10 million, this was "full-stop." Based on historical margins, this would not pay overhead for a week.

Instead of a company that would perform along the lines of historical averages, I saw a company with uncertain performance, impaired assets and little evidence of future business.

WHY WOULD YOU BUY A CONSTRUCTION COMPANY?

Short answer: There is no better way to amass significant wealth. Except, of course, the two best ways - marry it or inherit it. Sure, I would like to reap the benefits of one of Warren Buffett’s insurance companies, but I don’t have a spare billion dollars or so. While contracting takes money, it is money that is often within the reach of individuals.

But this road to wealth is littered with the bodies of the vanquished, the ones who reached and failed. It is high reward and high risk.

A fundamental guideline: in my experience, it takes construction experience to be a qualified buyer of a construction business.

When establishing a value/making an offer to purchase:

1.     Keep the price within about 1.0 to 3.0 times cash flow.

2.     Recognize the extra value of equipment, but the effect is probably not substantial in most except "heavy" contractors.

3.     Include a “look back” provision in your purchase contract as a way of settling up on matters that will be decided as jobs complete.

4.     Insist on a backlog that will provide a good start for the new owners.

5.     Obtain a meaningful transition process.

6.     In due diligence, look for general contractor back charges, establish a bonding line prior to closing and be very careful about the difference between what you thought you were told by owners/brokers and what you are seeing. Quiz current customers and any contractors you do business with.

PAY UP FOR QUALITY AND GROWTH. When considering the multiple of cash flow, move higher if the company is growing and fairly large, move lower if the company is small (your salary takes more of the "cash flow"). The term "quality" can mean a lot of different things, but make sure that you get a company that has some certainty to the future of the earnings stream although that is extremely hard to discern.

Buckle up, get ready for a ride! Good luck.