Because of the current downturn tremendous opportunities exist to purchase distressed contracting and construction supply businesses. But this strategy is high risk, high reward. How can you reduce risk and succeed? Three Key Principals are detailed below along with a case study to pull it all together.
1. Cash - It’s Only A Deal If You Can Make Great Money
In setting up a negotiation and purchase price strategy you should look at three values, the going concern value of the target business as-is, the potential value of the target to other suitors, and the value with synergies to you. Pursue transactions with a high synergistic value to you and a low current market price. In assessing other suitors, look around carefully, because of the current difficulty with financing, you may not have any competition. If that is the case, negotiate accordingly.
Yet, it does not really matter how cheaply you are obtaining the business and its assets if you cannot redeploy them in order to make a significant return on your investment. Make sure you have fully evaluated the financial impact and the cash flow requirements arising from your acquisition. Often the biggest risk in these transactions is the amount of time you will need to carry the business with negative cash flow. The immediate risk is running out of cash and ending up as a distressed seller yourself. The long term risk is that you lose so much from operations that your total cost of ownership including loses is too high to recover when the economy, revenues, and profits return.
2. Knowledge - Know the Industry
You must be able to dissect the company being sold and understand why the company is underperforming and how you will rectify the situation. Are there synergies from combining operations? Will the customers transfer? Is it a poorly managed business with a great location? Is it a case of too much leverage? How and why will you do better?
Be honest with yourself. For instance, if real value will come through getting the target business out of an expensive long term lease because you already have facilities in the local market, make sure you really can terminate the lease.
3. Vision - Negotiate A Complete Deal
Negotiating the best price is important but you must understand how this business integrates into your existing business. How will the larger entity work? Will the cultures mesh? How does two plus two equal five?
You must also be sure that all liens can be released and tailing liabilities will not surprise you. (Don’t ask the guys who purchased a major hardware supplier about buying back returned goods, lots of returned goods.) Is the intellectual property transferable to you? Work fast but be thorough.
A typical distressed business transaction revolves around an asset rich business which is underperforming often because of the economic cycle more than mismanagement.
For instance a construction equipment rental business is having difficulty maintaining bank lines. The Company has $5 million of equipment when purchased new which would have a “normal” market value of $2.5 million used. You are presented with the opportunity to buy the business and equipment for $1 million because this branch has never performed to expectations. Of course the business is losing about $250,000 a year at the time of the proposal.
In this case the buyer is an out of town competitor that would like to get into the business. Cash is tight for the buyer but they have some remaining credit lines with larger banks. The buyer assumes existing loans for most of the purchase price and hopes the economy turns in order to bring down the losses of current cash flow. The buyer has estimated three years to cash flow break-even and then significant profits for five to seven years. This scenario while not guaranteed makes sense for this buyer and the buyer proceeds.
It takes cash, knowledge, vision, a plan, and execution. When properly implemented, buying a distressed business can provide significant returns and is an excellent way to grow your contracting or supply business.
First Published in the March Issue of the Building Congress Bulletin, Vol. 10 No. 3 http://bcebaltimore.org/ for direct link to article (page 5) http://bcebaltimore.org/Portals/0/March%202010-Revised%20Bulletin.pdf
About the Author: Gregory Caruso, CPA, Attorney, Certified Valuation Analyst, is a Principal at Harvest Associates in Baltimore, Maryland. Greg is an expert in privately held business valuation, succession planning, and mergers and acquisitions with over 20 years of experience. He is author of the book 11 Secrets to Selling Your Business. www.Harvestbusiness.com 410-507-5441