We spoke to Tim Ludwig, Partner at Ohana Capital, about maximizing the value of businesses before selling. For the past 6 years, Ludwig has been operating Ohana Capital, an entrepreneurial investment firm that invests in small companies. Since the beginning, the company has invested in 30 businesses and continues to be very active in the market making 3-5 new investments per year.
1. What are the most critical factors in your evaluation of whether or not to buy a business?
“At the top of the list is a history of growth and profitability. We’re not looking to do turnarounds, salvage operations, or take a chance that we’re going to be able to make something dramatically better than it already is. We want something that’s already on a pretty good trajectory, so all we have to do is bring in a reinvigorated management team, with better governance, and continue it along that path to maximize potential.”
- Are your criteria different than most other buyers?
“Maybe in some ways, we have a speciality and focus on recurring revenue service businesses; things like alarm monitoring companies or how you pay your cable bill or cell phone where each month there’s that regular recurring charge. We typically look for businesses that have at least $750,000 in pre-tax profit and we also prefer to make majority investments by buying out at least 51% of the company. Other investors will do what they call ‘growth equity’, where they buy a minority stake and then take a seat on the board but we prefer to be controlling investors.”
2. What can a business owner do today that will help them get more money for their company down the road?
“Investors really like predictability and hate being surprised, we’re pretty risk averse by nature; anything that helps tell a business story that is aligned with that is key - you have predictability in the revenue streams and there’s no skeletons in the closet. A few examples would be clean books; if they’ve been reviewed, compiled or audited by a CPA firm for the past few years so that you know that everything ticks and ties. If there’s a strong middle management layer so there’s not absolute reliance on the seller, where if a seller goes away you lose 80% of the business because it’s a very relationship based revenue stream; that’s something that we would be looking out for. No customer or vendor concentration; if Walmart is 90% of your business, that would be something that’s worrisome to us because if they go away you could, very quickly, find yourself in a bit of trouble. And a predictable and diverse revenue stream, predictable more important than diverse; if you have a 5 year recurring contract, that would be preferable than you getting 20% of your revenue from 5 different channels. Anything you can do to reduce your dependence on a single customer or vendor and to have some predictability to those revenue streams would be most important to us.”
- Are there any tools or resources you would recommend?
“There are lots of great articles that you can find online now, much more so than 4 or 5 years ago. We’ve seen that when we approach business sellers in the markets, they are much more educated and aware about the sales process than they ever used to be. Just availing yourself of what’s out there, doing simple searches on terms that you think would generate the kinds of articles that you’re looking for is probably the lowest hanging fruit. The other thing you can do is start a few years in advance to develop relationships with brokers or bankers that may specialize in your market, as well as consultants in the industry that have been involved in sales transactions. Begin to learn how people think about buying businesses in your particular industry, what the valuation multiples are, where people go for debt, who the likely buyers are and just become educated early in the process.”
3. What are the biggest mistakes CEO’s make when trying to sell their companies?
“Not preparing far enough in advance or trying to rush the process through at the last minute. Sometimes somebody is surprised with an illness or some other catalyst that causes them to sell before they’re really ready, but if you have the luxury, getting a head start on it is probably the most important thing. The other area where we see mistakes made is just having unrealistic price expectations; you can take up an awful lot of your time, potentially that of your advisors, and other people that you may be working with to sell your business. If you don’t know what you’re trying to sell it for and then you come to the market and say, ‘I think my business is worth $50 million’ and the market says it’s worth $5 million, then you can take up a lot of your own time and other people’s time without any realistic chance of getting a deal done. The other thing that CEOs do is they don’t have an appreciation for the market timing. Like almost everything else in our economy, business valuations go through cycles; if you have the ability to do so, you want to try and time it so you’re selling closer to the top of the cycle rather than the bottom because for the same level of cash flow and growth, you’re going to make more money.”
- Can you give us an example of a time that happened?
“There’s not a specific example but related to the market timing, there was a pretty clear shift from 2007 into 2008, maybe 2009, where going into 2007 we were right at the top of the market and there were people out there, we talked to some of them, that thought they could wait one more year and still get the same kind of valuation. Things changed radically over that 12 month period and they had, pretty much, the same business that was worth then 20-30% less than it was the year before and a lot of them chose to not even try and sell their business going into the down part of the market.”
4. What types of businesses get the best valuations?
“It’s determined a lot by investor demand at the individual level and at the industry level, companies in fields like software as a service (SaaS) typically demand higher valuations than a manufacturing company of the same size because investors like those more. They see that there’s more of that predictable revenue stream and they have higher margins; just being in the right industry is a big determination of valuation. Outside of that, growing firms with good margins, low capital requirements so you don’t have to take all your money and put it back into heavy equipment or something every year, and recurring revenues are probably the biggest value drivers.”
- Can you give us an example of one that you’ve evaluated recently?
“There was a worker’s compensation claims management company; it’s an outsourced back office function, and there are not a lot of capital requirements because it’s basically labor that you’re hiring. Furthermore, it’s very scalable and has fairly predictable revenue streams as they charg a recurring maintenance fee every year. That company checked a lot of those boxes I went through, which made it appear to be a fairly low risk opportunity.”
5. What are the most effective ways businesses market themselves when trying to attract buyers like you?
“Finding the right firm to represent you is one of the major ways that they market themselves. Going back to what I said before about getting in contact with brokers, bankers, and consultants in your industry that specialize in that niche, makes a big impact. Also, knowing your motivation as a seller; are you trying to maximize the price that you’re getting, are you concerned about your legacy, do you want to take care of your workers, or are there other considerations? If you know that, it does help to market your business because you can then tell, more clearly, the reasons why you’re selling and investors like to have everything make sense. The internet is also becoming more of a tool; there are services out there like Merger Network, Axial Market, or BizBuySell that are kind of like Ebay’s for small businesses that allow sellers or intermediaries to post their businesses online for prospective buyers to view. Those online resources are becoming much more commonplace.”
6. You see a lot of businesses and business models in your line of work. If you were to start a new company today, with the intention of selling it in 5 years, what kind of company would you start?
“I don’t have a specific one but it helps to know the industry; a lot of successful entrepreneurs saw something in a workplace that they thought they could do better and that was the catalyst for them leaving and going out and doing it on their own. I’m not really in a position like that now where I see those kinds of opportunities but, generally speaking, it would be something that was asset-light, that didn’t take a lot of capital to get going or to continue to operate and grow it. Probably a service business, service companies are a growing share of the U.S. economy so that’s a good tailwind to ride. Also, something with recurring revenues so that I could sleep more peacefully at night knowing that checks were going to come rolling in and I didn't have to go out hunting every single day to bring in my revenue that month.”
7. Any other thoughts or advice for CEO’s considering selling their businesses?
“Even you aren't thinking of selling now, it’s good to start to act like it. As an owner, you will learn a lot and it creates good discipline, operationally, within your business to think about how other buyers would value and then want to operate your business. Many companies are operated as lifestyle businesses and that’s fine but you should at least be aware of how a different buyer would run your business, maybe with greater efficiency and potential for growth, and it also highlights areas where you may want to improve your business. Additionally, many buyers want you to stay through a transition period, 1-3 years is pretty common; I’d be ready for that and anticipate it. If you really think you want to sell your business and you think that you might be required to stay on because that is what will make the buyer most comfortable, then you need to work backwards on that timeline to identify when you really need to sell your business, assuming you’re going to have to stay on for a period of time afterwards.”