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AMPLIFY YOUR BUSINESS

EPISODE 54: MERGERS, ACQUISITIONS, AND STRATEGIC EXITS

Featuring John Carvalho, of Stone Oak Capital

In today’s episode of Amplify Your Business, Lance sits down with John Carvalho, President of Stone Oak Capital, a leading mid-market M&A advisory firm specializing in business valuation, divestiture, and acquisition advisory based in Edmonton. Listen in to learn more about mergers & acquisitions, how to position your company for sale from a strategic standpoint, and finally, how to make sure you are making sound decisions when it comes to purchasing other companies.

What is Stone Oak Capital? 

John Carvalho, now President of Stone Oak Capital, started off doing corporate finance and valuation at one of Edmonton’s larger accounting firms. Through his work helping businesses owners work through different stages of their deals John realized that he wanted to go out on his own and really dig into helping small to mid sized companies implement strategies to either sell or acquire other businesses. The priority for John? Helping entrepreneurs monetize the wealth that they’ve built into their businesses - after all, building and growing a business from the ground up requires a lot of money to be invested (also all the blood, sweat, and tears).

 

At some point all entrepreneurs are faced with the question: “How do I exit this business?” So, as an industry expert, what advice does John have?

Tip number one? Start thinking about it now, and think about it often. In fact, John thinks about exit strategies every day… and not just because it’s his job! Let’s face it, thinking about leaving a business that you’ve poured your heart and soul into can be really tough. Many business owners have an awful lot tied up in their business, whether it’s relationships and professional connections or even a large part of their own identity. There’s a lot of finality to an exit, certainly, but John can’t stress enough how important it is to get the wheels turning in your mind. 

Where this might be particularly difficult is with family businesses, as Lance shares in a personal anecdote about his family farm. As the eldest son he was next in line to take over the farm’s operations, an opportunity that he turned down in favour of creating a new business on his own. Even from a young age, just thinking about how much of his family’s history and generational identity has been wrapped up in that farm over time, he knew he wouldn’t be able to come to terms with being the one to sell. And if you don’t sell, you can’t reap the rewards and the equity that’s been put into the business throughout the years.

Thinking early on about how you plan to exit your business might be a challenge that a lot of entrepreneurs aren’t too keen to take on, but it can only help provide you with more options for exit, not to mention opportunities to increase the value of your business and to make it more attractive to prospective buyers.

 

How can entrepreneurs strategically position their companies in such a way that they can make a smooth exit?

John’s been thinking about this a lot lately, and the importance of educating entrepreneurs so that they can really maximize their wealth when they do make that exit transition. We’ll get to a little bit more on that later in the episode, but for now John shares the three things that entrepreneurs need to do in order to start the process of strategic exit planning:

  • Understand your objectives
    What are you trying to achieve in your business? Are you looking to get the most money out of it as possible by the end? There’s nothing wrong with that, a huge percentage of people go into business to create wealth for themselves and their families. Or perhaps you’re looking to create a continuing legacy that lasts long after you’ve left the business. That’s perfectly fine too! There are so many reasons that entrepreneurs go into business, there is no right or wrong (barring, you know, total world domination or something like that). Understanding that underlying objective is key.
  • Think about what kinds of exit would satisfy those objectives
    Now that you know your objectives, think about how you get there. Is a sale going to be the best path? If so, are you looking at a total sale of the entire business, or just a portion? Maybe you look to bring on a partner to help you get to the next level. Or maybe, in the case of a family business, you look to build the next generation up so that they are ready to take over. For example, if the goal is to create a long lasting legacy that continues on through generations of family members, selling the business to an external buyer probably isn’t the right exit strategy.
  • Have a realistic valuation of your business
    This often has a restrictive impact on an entrepreneur executing on an exit strategy, simply because so many owners overvalue their business and have unrealistic expectations of what it’s true worth is. This is where it is absolutely critical to look to a trustworthy, experienced advisor who is unbiased, impartial, and skilled at valuation. 

 

If so many entrepreneurs are wrong about the value of their businesses, how do you get it right?

Theoretically value is the present value of future cash flow. Prospective buyers are looking at the expected future cash flow of a particular business and comparing that to how risky it will be to earn that money. Generally, in terms of smaller businesses, investors are looking for about a 30% return on their investment. For example:

If John buys a business for $1 million, with $500,000 of that coming out of his own pocket, he wants to see a 30% return year over year on that investment.

That million dollar business is a pretty risky investment though, a lot can happen between competition, operational risks, human resources risks, etc. So it’s really a balancing act of a ton of different factors when it comes to finding the value of a business and navigating that tight rope comes down to experience, knowing the market and what buyers are actually out there, and being able to read market dynamics compared to what the business is actually generating. Long story short, an advisor is absolutely an asset in these situations.

We only had about 45 minutes with John, so this is definitely a reader’s digest version of company valuation, but it’s a good starting point to get business owners thinking strategically. Stone Oak Capital does offer valuation as a service, so don’t hesitate to contact John if you’re ready to dive deeper! 

 

What about EBITDA valuation multiples?

Lots of people speak about valuation in terms of ‘multiples’ & EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). However, a multiple is just the inverse of the risk rate. In our example above the multiple would be:

Inverse of Risk Rate (30%) = 1/30% = Approximately 3x

Multiples certainly come into play when it comes to valuation discussions, but it’s important to understand that they really are dependent on the risk being taken. So, the less risk a business poses to an investor, the higher multiple an investor can expect to pay.

 

Let’s talk about a business’ dependency on it’s owner. What role does that play in valuation?

When looking at smaller businesses, owner dependency definitely plays a part. After all, a lot of a small business’ goodwill and relations are directly tied to the owner. So what happens when the owner leaves? Knowledge transfer is always a risk for owner dependent businesses.

John tells us that the biggest risk associated with owner dependency is those aspects of the business being transferable to someone else. How much of the business vanishes with the owner? Buyers really have to understand whether or not they can successfully take on those relationships. If the answer is no, then truthfully that business could have a value of zero. If no relationships can be transferred to the new owner, that business is not saleable.

There is an importance around developing systems, procedures, and policies that help ensure not everything falls to the owner. These are what John refers to as the table stakes that help make your business saleable. When one owner leaves, the buyer needs to be confident that the business keeps running turnkey with employees and customer relationships intact.

 

So you have an owner dependent business, what steps can you take to make your business more self-sufficient?

A large concern for many entrepreneurs is not having the margins to take on a big, expensive, well oiled upper management machine that can transition with the company to a new owner.

John suggests going back to what your objectives are. Are you looking to make the most money possible out of your exit, or are you looking to find an internal replacement that you can cultivate over time into ‘the new you’? Could you maybe find a competitor who just wants access to your customer base instead of continuing on your brand? There are lots of ways to position your company, you just need time to do the strategic thinking that will get you where you need to be.

 

Besides systematizing things and thinking through how you keep value within the company, is there anything else that needs to be done within the lead up to a sale?

When it comes to maximizing that dollar value you can look at a number of different areas, including:

  1. Tax planning. Speak to an accountant or tax expert about how to structure your business in a very tax efficient manner. 
  2. Buyers really focus on the numbers game. Numbers are a massive driver of value, but there’s also the flip side around the narrative. Lay out a road map for the buyer that articulates how you’ve planned to grow, increase value, move into new geographies, build out adjacent products or services, etc. Getting that story of how the business develops over time into the buyer’s head can really get the juices flowing and a buyer might be willing to pay a premium.

 

In terms of numbers, how do you make them look appealing? How many years should you be looking to show?

Within a 2-year window you can definitely make a business look really attractive to a buyer. Especially if you have a process around being able to forecast the future. For example, if you are able to show that you forecasted, budgeted for, and subsequently attained those 2 years of great numbers, you have a great negotiating chip on your hands because suddenly your future forecasts look a whole lot more credible. A lot of owners don’t realize that you really can negotiate based on things that haven’t happened yet, provided you can prove you’ve been able to hit those marks in the past.

 

Let’s turn the tables for a minute. What advice would you give to someone who has some money in the bank and is looking for acquisition opportunities?

Acquisitions are hard, there’s no two ways about it. But if you have the appetite for growth and the capability and dedication to get it done, acquiring another business can be incredibly fruitful. John points out that it’s easy (in relative terms) to grow from the $1 million mark to the $2 million mark. What’s more challenging is getting from $20 million to $40 million. Business owners looking for this exponential growth often have to apply an acquisition strategy rather than staying true to their organic growth path. 

There will always be challenges with an acquired business, even once the deal is closed. If you’re able to see the potential, work the deal, and play the numbers game where you may have to make offers on multiple opportunities in order for just one to pan out, that may just be the difference between growing slowly and doubling your business year over year.

 

What can you do to mitigate the failures, if they’re inevitable?

John mentioned acquisitions being a bit of a numbers game. You could make 10 offers and have them all fall through, for the 11th to close. What you don’t want to do is be afraid of those failed deals and jump the gun by overpaying or not structuring your deal carefully. Don’t put your existing business in peril just to close a deal. Be patient and hold out for the deal that really works for you. It can take a lot of failure (no one’s sugarcoating here!) but you’ll be rewarded when you succeed. Oh, and hire a trusted, disciplined advisor to help you navigate the tricky waters of acquisition deals - it’s a must!

Acquisitions can also fail in the end (even after the deal has closed) because of a poor transition period. So don’t neglect this part of the deal. Make sure that the existing owner is going to support and buy into the transition phase until your people are truly ready to fly solo with the newly acquired business. Keep them in place with incentives and proper deal structure.

 

Looking to learn more about mergers and acquisitions? 

You’re in luck! John has a course in development right now that will educate interested parties on all the things they need to know and do when looking to buy/sell a business. Topics covered include:

  • How do you value a business?
  • How do you structure the transaction?
  • How do you mitigate risks?
  • How do you even find a buyer or a seller?
  • How do you engage with a buyer or a seller once you find them?
  • And more…

The course is currently in beta testing, but will walk through the difficulties and the opportunities of acquiring and selling businesses. Get in touch with John for more information on the course and when it will become available!

 

Lastly, a few words on what has been happening in the markets since the start of the pandemic.

The markets are really quite regionalized, in Alberta we’re heavily oil & gas based which hasn’t been a great industry transaction wise, but other areas of North America are on fire. A company showing success, especially growth, through the COVID-19 pandemic is extremely attractive for a prospective buyer. Think about it, if you position your company as an investment that keeps growing even when the world is essentially shut down, that’s pretty impressive.

Where there may be uncertainty is when it comes to thinking about the ideal moment to buy or sell because of the difficulty in predicting exactly when things will ‘get back to normal’ perse. A lot of more risk averse investors would want to see a little more normalcy before jumping into things, but the conversations are definitely already in place for deals to start taking shape as we come out of the pandemic. There is also a significant amount of capital flowing around in North America with some very deep pocketed investors, which will almost definitely prime the pump for deals going forward over the next few years.

 

 

Thanks for tuning into another week of Amplify Your Business, we hope you learned something new today about mergers and acquisitions! As always, contact information for our wonderful guest is below, and we certainly recommend getting in touch with John if you have questions about Stone Oak Capital, his services, or the markets in general.

 

Contact John at Stone Oak Capital:

 

On social media:

Twitter: https://twitter.com/stoneoakcapital

Facebook: https://www.facebook.com/stoneoakcapital/

LinkedIn: https://www.linkedin.com/company/stone-oak-capital-inc-/

 

On his website:
 https://stoneoakcapital.com/

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