To discuss the business community and the climate for mergers and acquisitions and business transitioning here, I spoke to Grand Rapids business broker Max Friar of Calder Capital. He has a unique perspective on business brokers in Grand Rapids.
What does it take to be one of the better known business brokers in Grand Rapids?
Calder Capital works primarily with small businesses – manufacturers, service providers, distribution companies – that range from $500,000 to $10,000,000 in revenue. Like many mid-size Midwestern cities, we have a lot small businesses that were started 30-40 years ago. Many owners have done a great job operating their business, butdo not have a natural successor. Oftentimes their kids move away or find other occupations. In this way, this area is probably no different than Lansing, Toledo, or South Bend.
What makes Grand Rapids different, in my opinion, is a strong, conservative, honest work ethic that runs thick through the small business community. I think that West Michiganders like to do business with each other because in general there is a sense of trust that permeates business relations. Certainly companies have contracts, but I genuinely smile at how many people do business on a handshake. That says a lot about a community. When people ask me if I work outside of West Michigan, I tell them yes, but honestly I prefer not to.
How did you get involved with business brokering in the West Michigan area?
I took a telemarketing sales job out of college. It was a burnout job – prospecting, calling, hard selling, rinse, and repeat. I look back fondly on that job because I learned more about small business, sales, hard work and dealing with people during my first 6 months than I did in 5 years of college.
To make a long story shorter, after two years of making 80-100 calls dials per day and working until 8 PM for $35,000 a year, not only was I burned out, but I knew there had to be a better way to earn a living. My college roommate told me about a business development position at an M&A firm where he had been working as a financial analyst. I applied and got the job.
Now, this is really interesting, and is a testament to the importance (or unimportance) of experience: I did not even know what M&A was. I had never taken a business course in my life. I was hired for two reasons: 1) I was interested and had some basic experience updating websites (this was back in the html days); and 2) I wasn’t afraid to telemarketto business owners. That was 2005, but those two reasons (or personality facets) served as the catalyst to get me where I am today.
I ended up staying with that firm for three and a half years. In general, I was permitted a lot of freedom and learned a lot. I ended up falling in love with M&A. Working directly with business owners was a great experience, and I loved learning so much about different companies. It had all of what I loved about college – every three months I got to try something new out. (Of course after I graduated, I was herded into a cubicle to do the same thing for eight or nine hours a day. Makes a lot of sense, huh? Shoot me.)
I left the firm in 2008 to be part of a start up, however subsequently found myself back in M&A as part of another startup in 2009. I remained with that firm until 2013, when Calder Capital was born.
What is your favorite part of your job?
What job? No, I’m joking, of course. I have two distinctly favorite parts: 1) I love creating the necessary limited auction style marketplace to get the best possible price and terms for my clients. This kind of environment allows for subtly bidding the price and terms up. There is nothing more rewarding than building and executing this type of sale for clients; and 2) I love being able to freely communicate. When I did not lead my own firm, there was a communication barrier between want I wanted to communicate with the client and the company allowed me to communicate. Today, I get to say what I want when I want to. Because I am a fan of the absolute truth, I now have conversations that really move deals when and where they need to be lead.
For the small business owner thinking of selling his business, what are his chances of success? How can he make the process smoother and more successful?
Most owners have varying definitions of success. Some owners want a boatload of cash at close. Some are burned out and simply want the burden of ownership removed from their back.
If the owner wants the highest price and best terms (i.e., the least risk in a transaction), the business must have two characteristics. The first is that it must be marketable. In general, businesses are not very marketable when they are essentially selling employment. For example, if the business is producing $85,000 cash flow, and the owner is working full time, what is for sale is a job. There are many opportunities to earn $85,000 without taking on the burden of ownership. Secondly, if the criteria is there, the owner must be willing to engage in the creation of a limited auction-style business-for-sale process. It is very difficult to negotiate effectively and with confidence without the presence of backup buyers. Furthermore, if buyers know that there is competition, they are psychologically inclined to put their best foot forward when offers are requested.
What is the small business owner’s most common mistake in valuing his or her business?
Great question. There are four recurring challenges that cause expectations to become misaligned:
- Reliance on another owner’s experience (or hearsay in general). Just because the neighbor sold his $10MM manufacturing business for 1.5x sales does not mean that your liquor store will sell for the same metric.
- Formation of opinions of value based on little or no professional guidance. I would strongly recommend having your business appraised by someone who might be called to perform on that appraisal. I was recently asked to meet with the owners of a small retail business and was sent a recent appraisal they had commissioned. The appraiser did not do transactions, just theoretical business appraisals. This company did not have a lot of equipment or inventory. Its cash flow was approximately $250,000/year including the owner’s compensation. The appraiser valued the business utilizing a methodology and cap rate that would apply to a small cap publicly traded company. The result was a valuation of $1.5MM. Very sad indeed. If it was a crime to create unattainable expectations related to a major life event, that appraiser would be in jail for life.
- Valuation of small businesses based on the income that they produce. Many owners falsely assume that they will be paid a multiple of 3-5x the total cash flow of the business. Using the example above, it would not surprise me to meet with the owners of a business with similar characteristics. In fact, I might show up to have them hand me a sellers discretionary earnings analysis prepared by their CPA. Let’s say that’s $250,000. In this case, many owners would expect the company is worth $750,000 – $1,000,000. That $250,000 includes the net profit of the business, owner’s compensation and perks (personal expenses paid for by the business that would not necessarily transfer, such as meals/entertainment, life insurance, cell phone, personal gas, and home office renovations). Added back to that figure are any non-cash expenses such as depreciation and amortization. The mistake that owners make is not adjusting for their replacement. If the cash flow of the business is $250,000 including their $100,000 salary for managing the business full time, then a buyer is going to pay themselves or a manager to assume those responsibilities. That amount must be deducted from cash flow to calculate cash flow available to servicing acquisition debt/ROI. A good rule of thumb for a small business such as the one described above would be 2.5 x adjusted EBITDA. $250,000 – 100,000 = $150,000 x 2.5 = a $375,000 purchase price.
- An owner’s assumption that a buyer will write them a check for the purchase price. As is the case with most small businesses, the business relies on the owner – whether it’s client relationships, a particular skill set, or his relationships with employees. To a buyer this implies risk, and buyers mitigate that risk by structuring transactions with seller notes and earn outs (contingent payments). Using the above example, a buyer and seller might agree on a value of $375,000, however the buyer may offer $250,000 cash at close and a $125,000 seller note over 3 years at 5% interest.
How has the West Michigan business community changed since you opened your first business here?
Considering Calder Capital opened in 2013, I wouldn’t say a whole lot has changed. We survived the winter. And now we’re becoming better known as one of the more reliable business brokers in Grand Rapids.
This area seems to be growing in leaps and bounds. Do you see any challenges to be overcome for Grand Rapids to thrive as a whole?
Yes, the three P’s: Parking, Potholes and transition Planning The first two are largely out of my control, however on the latter I will state (scream): “Owners, you will transition out of your business. It is inevitable.” The best transactions that I have been part of are ones where the owner has done at least a small amount of planning related to what they need monetarily and how they want the transition to play out (a buyer who will retain the company’s employees, allow the owner to work a few more years, or allow the owner to consult in the industry). Do not wait until something forces a sale. I can guarantee you that a fire sale will not make you happy and will not leave the legacy that you want to leave. Talk to someone about the sale process if you do not have a natural successor. Find out what your company is worth and how it is likely to be paid for. Talk to your wealth manager and CPA to understand what you need and how to mitigate the effect of taxes, respectively. You should not transition out of your business without knowing the complete set of facts.