Selling Out

By Lloyd Graff

I have been studying the process of buying and selling machining businesses for the past year. Companies have approached me to advise them on what to ask for their companies and others have called to find viable options to purchase. Our machinery business, Graff-Pinkert, has helped facilitate many transactions through the years and with baby boomers looking to cash out and other firms anxious to add sales and expertise, the demand for advice is growing briskly.

In this article I’ll give you a taste of what I’ve gleaned.

The market for small businesses, machining and otherwise, is extremely fragmented. Even with the Internet and some nascent business clearinghouse sites, it is disorganized. The market for a Haas VF-2 machining center is much more transparent than the market for companies that run them. Business brokers and advisory firms have traditionally rigged the system, much like real estate brokers on houses, by making it hard to gain visibility for small and medium sized businesses. In a lot of states you theoretically need a license to broker a business, though you do not need one to sell the assets or give advice.

From my observation business brokers who sell funeral homes and barber shops usually are out of their league trying to sell manufacturing companies. Their focus is local. If they are trying to go national they may try a few Internet sites or aim for buyout groups. This is a logical approach for somebody who can’t talk the talk, but it works quite poorly, from my observation, for businesses under $20 million in sales, which is the minimum that private equity groups are normally interested in. The exception is firms who are trying to consolidate a particular niche product. Job shops rarely fit that category.

Despite the fragmentation and the structural impediments of the brokers, buyers and sellers can ultimately find one another by luck, word of mouth, or thoughtful target marketing. Then the question of what a going business is worth comes into play.

A business owner must quickly learn the word “EBITDA” to play the game. It is the universal English code word for “Earnings Before Interest, Taxes, Depreciation and Amortization.” It gives a picture of a company’s profitability as a percentage of its total revenue. It is a handy way to measure cash flow.

Most potential buyers will pay a multiple of 3-5 times EBITDA for a profitable, stable machining business, but growth potential, customer compatibility and management acumen may push it up. Buyout groups tend to stick to a rigid EBITDA multiple while an operating firm with a specific need may pay a higher multiple.

Buyout groups gobble up a lot of ripe companies because they are proficient at the game and can move fairly quickly. A lot of sellers are looking for a rapid exit, and the buyout firm can oblige. The downside is that they bring in outside management that often screws things up quickly, and they have very little patience. If owners stay on after such buyouts, often the experience is quite ugly. There are many exceptions, but a private equity buyer who is just buying numbers often makes for a mess before they figure things out or the lender calls for the auctioneers.

I haven’t mentioned lawyers in the piece, but you can probably imagine that they often bring a lot of expense and legalistic hand-wringing to justify their fees. Non-disclosure agreements, which are a part of the buy-sell ritual, are often reviewed by lawyers, which usually slows the process but add to their incomes. I think it is difficult to enforce non-disclosure agreements, but they do put potential buyers on notice that they should be discreet, and they allow sellers to veto buyers they distrust.

With all of the impediments it is surprising to see that a lot of small and medium sized machining firms do change hands. It takes time and persistence, and usually some good counsel, but it can be done.

Question: Is it better to grow organically or through acquisition today?

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10 thoughts on “Selling Out

  1. AvatarGreg

    We’ve looked at trying to sell our family business a couple of times but the valuations are so absurdly low it made no sense. The analysis always seems to indicate that after taxes and transaction costs you end up with about 2 years’ worth of net profit. Small businesses just aren’t worth what they’re worth!

     
  2. AvatarMIld Bill

    I don’t know the answer. I started a job shop from scratch a year ago. My hope is to
    grow organically and at the same time, I am on the lookout for a machining business
    that makes sense to buy. I would have been glad to buy an existing shop, but In my area, the only one available was worth no more than the assets. In my mind, experienced
    employees and existing customers would be very valuable. Glad you brought it up, as
    this question is always on my mind.

     
  3. AvatarVictor

    Thanks, Lloyd. Great piece!

    I own my business – a small, two-person engineering concern, and I expect to retire in about 10 years. Occasionally I wonder about the end-game, but I don’t need to worry about it. I already have my full retirement in the bank, so anything from the sale of the business is gravy. I have thought that I really “own a job” rather than “own a business” because only a person with some very specialized engineering skills could take over this business, so I’m not sure how sale-able it is.

    Sometimes I think I could just give it away to some worthy individual I like. But 3-5 x EBITDA is a lot to leave on the table, even if I don’t need it. A fun project to look forward to!

     
  4. AvatarCharles D. Schultz

    Having experienced a buy out as a management employee I agree that outside experts can quickly screw things up. In the case of my former employer they needed just 6 months to trash 12 years of hard work.
    I encourage small business owners to learn from the story of an old friend of mine. He and his brother were long time employees of a small fabricating shop. The business owner wanted to retire but could not find a buyer willing to pay his price who would have “treated his life’s work” with respect. So he called these brothers into his office and told them to bring a coat and tie to work the next day. They figured they were going to a customer’s funeral and asked who died. The owner laughed and said: “Me eventually. I’m introducing you to my banker so we can find a way for you boys to buy this place. You know the trade and treat customers and coworkers well. Why should I trust my baby to idiots?”
    They were shocked but a deal was made. Twenty years later the “baby” is several times bigger because the founder thought outside the box. BTW, he got his price without ruining the company in the process.

     
    +4
  5. AvatarMike Ray

    Lloyd – you are asking good questions, permit me to ask you and your readership two more:
    1) For the outside investor / buyer, what are the obvious and non-obvious signs that demonstrate the business organization is able to generate sustainable profits and grow without daily oversight of the owner?
    2) For that same investor / buyer, what are the obvious and non-obvious signs that the business organization will fall apart?
    I have my own ideas and experiences but would like to hear yours.

     
    +1
  6. AvatarEd Gnifkpowski

    Responding to Mike Ray.
    If you don’t know these things about the type of business you are looking at you are most likely to mess it up no matter what you do.

     
  7. AvatarMike Ray

    Ed,
    You are correct that a working knowledge of a specific industry and the business practices of that industry are necessary for success; Lloyd provided several examples proving your point. While I have thirty years in the machining industry , started four 3-5 employee machine shops and have investigated taking over ownership of others, I have never been through the process of buying one outright. Lloyd raised some interesting points and I would like to know what you and others have to add. There is always room to learn more.

     
    1. AvatarJohn Ribic

      Mike,
      We try to run our business like a company we would want to purchase. A few things we do and I would want to see in any business that we would acquire. The development of consistent processes, documented at a work instruction level. Job routers moving through the shop with each order that are filled out properly and time tracking for each job. Several levels of training of employees with competency records. In our shop we have Machinist 1 through Machinist 3, Set-up personnel and Programmers. We have several employees at each level and each employee is working to move to the next level. This way you do not have one person with all of the knowledge and responsibility. If buying a production shop, I would look at the repeat orders from customers, I believe it shows that the shop is doing a good job and has loyal customers. We generally do about 75% repeat work and 25% new work. We are currently looking for good machine shop acquisitions and these are the things we will be looking for as we evaluate different companies. Hope this helps.

       
  8. Avatartom

    Want to thank Lloyd who spent a lot of time with me on our first machinery business divestiture in 2002: Alger Manufacturing.

    Over the years, the best advice I can give to business owners seeking a liquidity event include:

    • If you are planning a liquidity event, do not lock-on to one potential acquirer / investor. Create a competitive environment for your business where the #1 prospect always believes he is in second place.
    • Audited statements will enhance your company’s value by minimizing risk to the acquirer
    • Hire a licensed investment banker, not a business broker for all the reasons Lloyd mentions
    • Strategic investors may provide the greatest value for your business
    • Strategic acquirers will take a lot longer to do a deal than the financial acquirer….
    • When asked to roll part of your equity with the acquirer, think and evaluate what “second bite of the apple” means.
    • Before you start any process, understand the after tax cash to you….
    • Do an annual strategic / financial plan out 3 years.
    • Put a plan in place now and share it with key advisers
    • Keep everything confidential
    • Keep good records every year of the add-backs: those owner expenses run through the business
    • Do whatever you can to minimize customer concentration
    • If the buyer wants to keep you on, remember that the honeymoon generally doesn’t last more than 12-18 months
    • Consider acquirers from Asia.
    • Business owners generally are too close to the grindstone to recognize it might be time to take some chips off the table

    Grand Avenue Capital Partners, LLC
    Investment Bankers Member FINRA SIPC
    180 S. Lake Avenue, Suite 205 Pasadena, Ca 91101 USA
    http://www.gacpllc.com

     
  9. AvatarJohn Ribic

    I believe with a lot of baby boomers looking to retire, there will be acquisition opportunities over the next decade. It is great to grow organically and we are always looking to grow with existing and new customers, but growing with acquisition has its advantages also. It may allow you to gain a large customer or break into a new market or industry. It may allow you to gain access to new equipment and new processes with employees that are already trained to run them. The key hopefully is to find a win-win situation. One where an owner is proud of what he has built and wants to make sure it is successfully transitioned to new owners and the buyer is willing to be open minded and listen to the suggestions of the previous owner and the staff.

     
    +3

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