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In our continued quest of radical transparency, follow along as we are openly sharing information to build trust and keep all stakeholders updated through a monthly newsletter. Thanks for joining us on this journey!
TLDR
Took some much needed vacations with family
Maintaining our deal flow by increasing activity output (and adding help!)
Deep Dive: Understanding Valuations in Small Business Acquisitions
Final Thoughts: Persistence is key
Shoutouts
To our individual Search Mastermind Groups for ongoing camaraderie (aka "searcher therapy") and for sharing networks and connections.
Landon Mance and Kevin Halbert for their knowledge and insight into owning companies in the tree care industry.
Our friend and successful searcher, Garth Fasano, for his continued wisdom, support and possible deal flow!
Our SBA guru, Bruce Marks, for his very quick yet thorough analysis of the lender’s perspective on the many deals we throw at him.
Wins & Losses
Win: Family Time! → Duncan and Josh both spent a period of time in July away on vacation with their respective families. At this point in the search process, stepping away from the day to day search game offered some much needed rest & relaxation, and both partners returned with a new sense of energy and opportunity!
Win: Extending our Search → This marks the first month of income actually hitting our BPH bank account, which is a crucial lifeblood to full-time, self-funded searchers.
Win: Finding Deals in the Slow Months → Experincing our first summer of search was a telling experience, so we picked up the call volume and email outreach to maintain our monthly KPIs.
Loss: Passed on Good Companies → We had to pass on a few deals with companies that we really liked but there were some potential issues that came up that we could not mitigate.
Loss: We Lost our Interns → Both of the interns that were with us last month unfortunately had to leave the team for other opportunities, but we've already begun backfilling those open roles!
Activity by the Numbers: July
306 = Newsletter subscribers
40.2% = Last month's newsletter open rate
33 = Deal-specific outreach to CO business brokers
20 = Deals evaluated
10 = Meetings with sellers/owners
0 = LOIs submitted
Subject Deep Dive:
Understanding Valuations in Small Business Acquisitions
Purchase price is a crucial topic in small business acquisitions. Several key factors must be considered when aligning a purchase with a seller. Our process of evaluating or arriving at a purchase price (valuation) has three main components:
Does it “pencil” with the bank?
Is there enough money in the business to keep it running (working capital)?
Are we paying a fair price?
Does it "Pencil" with the Bank?
Debt Service Coverage Ratio (DSCR): DSCR measures the unlevered cash flows available to pay down the debt used to purchase the business. The first step to finding the DSCR is converting net income to the buyer’s discretionary earnings. Typically, the seller’s broker helps by transforming net income into EBITDA and then into the seller’s discretionary earnings (SDE). Once we have the SDE, we add a compensation package, taxes, and expected replacement costs to arrive at our buyer’s discretionary earnings. From there, we subtract an estimate for annual CAPEX investment and tax distributions to get the unlevered free cash flows. We then divide that number by the total debt service to see where we stand. As most banks require, we target a DSCR as close to 1.5 as possible, which means our cash flows will cover our debt payments 1.5 times.
We aim for a DSCR of 1.5 or greater to provide some wiggle room for the expected J-curve (the initial dip in performance that often occurs after acquiring a business, followed by a subsequent recovery and significant growth as operational improvements and strategic initiatives take effect). A lot of opportunities stop right here for us, because there is no way we can make this deal work based on how high the purchase price is and how that affects the DSCR.
Working Capital: Is There Enough Money in the Business to Keep It Running?
Working capital has been the biggest challenge in acquisition opportunities and is often greatly misunderstood. To understand working capital requirements, we examine 24 months of balance sheets, remove cash accounts, and subtract current liabilities from current assets. We then look at the minimum, maximum, and averages over that period. We aim to have enough cash in the bank at any point to cover the maximum cash requirement. We also use the cash conversion cycle calculation to understand the time requirements around our working capital needs.
For example, if working capital requirements are $1M and the purchase price is $5M, but no accounts receivable, inventory, or cash is left in the business, our effective purchase price is $6M, not $5M. This working capital adjustment to the overall price significantly impacts the DSCR.
Are We Paying a Fair Price?
Once we address the deal penciling and working capital concerns, we conduct a comparable company analysis to ensure we are not significantly above the market price. For our comps analysis, one resource we use is the Searchfunder BVR transactions tab. We grab the correlating NAICS codes, find 5-8 transactions in the similar size and assets industry, and take a median of the given multiples.
Here's the Deal
We want to execute on deals and pay owners what they deserve because they deserve to reap the rewards of their hard work. However, the deal must first make financial sense for us. If we try to bring the purchase price down, it's not out of rudeness but because the deal simply does not pencil.
Final Thoughts
Josh here - As we pass the seven month mark in our search journey, it's clear that this process is a blend of incredible opportunities and ever-evolving challenges. Duncan and I have navigated through countless prospects, and while the path hasn't always been smooth, our commitment to the goal remains unshaken. The most common advice from seasoned searchers resonates deeply with us, especially at this point in our search: Just stay persistent and keep doing what you need to be doing, and it will eventually pay off.
So here’s to the journey ahead, to persisting through the highs and lows, and to the exciting opportunities in front of us.
“Nothing in the world can take the place of persistence. Talent will not; nothing is more common than unsuccessful men with talent. Genius will not; unrewarded genius is almost a proverb. Education will not; the world is full of educated derelicts. Persistence and determination alone are omnipotent. The slogan ‘Press On!’ has solved and always will solve the problems of the human race.” - President Calvin Coolidge
Your support fuels our journey forward, and we are immensely grateful.