Last month’s column reviewed how to improve business growth and company value, especially for owners getting close to retirement age or a sale to another company. The column was directed at companies with 10 to 20 employees.
This month, we review the market for larger contractors with 25 or more employees, being paid in the “union” range, working for a firm with an earnings before interest, taxes, depreciation and amortization (EBITDA) number close to $5 million or more. If you fall under this umbrella, we have something to work with.
Before we jump into the financial discussion, please note that all the comments regarding marketing and proficiency also apply to larger companies. If you have formal programs in place to attract business and track performance with the ability to demonstrate how these programs have performed, you are in a much better position to “sell” what you are doing.
I have worked in this segment of the financial world. Buying and selling companies was what I liked to do. And when employee stock ownership plan (ESOP) transactions resurfaced that was even more fun.
But we are in a funky mergers and acquisitions (M&A) market right now. We also need to deal with higher interest rates, which reduce company value because the rate increases absorb more cash than they used to. Add in the crazy numbers associated with inflation and supply chain issues, and you wind up with having to supply data that spells out what you do, how you do it and how it compares to industry metrics. In addition, both historical and projected financial reports need to demonstrate that future cash flows will cover any acquisition debt generated because of the transaction.
To get a better handle on this I called Nathan Perkins, managing director, ESOPs, for FMI Capital Advisors . Nathan does M&A work with a specialty in ESOPs. We have worked together on some deals primarily dealing with construction-related companies. I wanted to get a feel for the current M&A market. Nathan said basic M&A is very soft but that he was working on several ESOP transactions. When I probed further, I was surprised to find out that the bulk of his work lately is collaborating with contractors. Consequently, I educated Nathan about what I was doing currently and asked him to talk with me to help educate Equipment Today readers. He agreed.
So, let’s assume a contractor has a company that meets the suggestion of more than 25 employees and a $5-million EBITDA number. And this contractor may want to sell out or buy a competitor. Or it may be time to clean house and make some technological changes that will hopefully improve the company’s valuation and cash flow.
In each case here, I would suggest compiling historical (normalized) financial results for the last five years, as well as a five-year projection based on a set of supportable assumptions. If nothing else this exercise may cheer up your banker.
I know this sounds like a lot of work, and it is a lot of work. However, the results help you understand your business from areas that are above average to areas that need work.
If you decide to move ahead with a sale, a person like Nathan would provide you with examples of a reporting format and support documents required. He would then dive into every line item in your reports and question you about the results and supporting documents, and together, you would wind up with a data set fit for insertion into an offering memorandum for potential buyers and loan officers. Obviously, if you are selling, the potential buyers are reading the memorandum, and as a potential buyer, you will be reading the memorandum to see if there is any further interest.
ESOPs add a lot to both sides of the equation. Your company can establish an ESOP and sell off between 30% to 100% of the company. And if you have an ESOP, you can purchase other companies, getting substantial tax benefits associated with the ESOP.
If the owner wants to monetize his/her investment in the company, the ESOP could buy a portion of the company and receive tax benefits, with the seller having the potential of paying zero taxes on the sale.
The bottom line is that ESOPs provide tax benefits to the seller and reduce taxes paid by the ESOP (if any). In addition, ESOPs help you attract new employees and retain the ones you have since the employees have an ownership interest in the ESOP that could produce a substantial payout in the future.
If you either plan to sell outright or use an ESOP, a lot of work is required, and costs are involved to make it happen with a continuous cost going forward regarding the ESOP.
One other option I did not mention was an employee or management buy-out where a portion of the agreed-upon value is paid at close, and the balance paid out on a note or an annual earn-out. These types of transactions are popular, but with current interest rates and pandemic supply chain issues, it may be tough to get the bank to buy in to fund the transaction.
And as I mention every month, try to outsource a lot of the financial analysis, use a format like what you would need to do an ESOP and then get a tax review to determine the tax obligations/benefits being created. And from there the board decides how they wish to proceed.
This issue is more complicated than I can cover in this column. But I can tell you the ESOP process works if you have the cash flow to cover debt service. Reducing the tax liability does help with the cash flow.
Nathan can summarize the ESOP in more detail than I can. And with his experience working with contractors, he can suggest the problem areas lurking out there. You can reach Nathan with the information below:
Nathan Perkins, managing director, ESOPs, FMI Capital Advisors