How to manufacture an exit plan

With metals/material markets down and financial markets up, the once booming M&A “ocean of opportunity” to sell the company you built has become a very small pond. How does an owner exit today without taking a bath in the real value of his or her business?

At the Washington-based Institute of Scrap Recycling Industries’ (ISRI’s) 2017 ISRI Convention & Exposition, I told attendees at the Economy Spotlight that this was the time to be a buyer not a seller. This was the time to use your resources to capture more market share.

It’s now 2019 and the reasons may be different, but it is still difficult to make the kind of money we all once made from the metals markets. For some business owners who have a longer time horizon, that still represents opportunity.

For others who have spent their lives in the ups and downs of our industry, it’s time to think about exiting because it might be a long time before we see the higher points of another commodities super cycle.

Types of buyers

Many of the buyers shopping for businesses today are very different than those who were active the last time around. The buying pool can be grouped into four categories:

1. Traditional large synergistic buyers who are in the business and are just adding volume and/or locations. (This was the main buyer active in the last cycle.) The problem with this group of buyers is they are not using the same expansionistic business plans that they once were and are bargain hunting, so getting a good price is hard.
2. Foreign buyers using cheap currency to buy U.S. assets. Generally, maintaining a company’s culture can be more difficult with this type of buyer.
3. Financial buyers who see commodities being so out of favor that they are starting to build a portfolio of companies they plan to own until the next super cycle, when they will sell them. Again, these buyers tend to be bargain hunters.
4. Manufactured buyers for small to mid-sized companies.

This article focuses on the manufactured buyers. These are people who often have worked in or around the scrap recycling industry or for a large company and have accumulated enough capital that they have begun thinking about working for themselves instead of for that big corporation.

Manufactured buyers

Manufactured buyers have enough capital to make significant down payments on the purchases of businesses and then rely on a bank loan to finance the rest. Many have been thinking and looking for a business to acquire for some time, so they have gotten preapproval from a bank and bring new and innovative management ideas that may breathe new life into the businesses they buy.

This type of buyer is looking to buy a job, meaning he or she wants not only to buy the company but also to work in the company. For many sellers, manufactured buyers are ideal buyers as they want to retain the purchased companies’ employees, want to work through a transition that is supportive of the purchased companies’ vendors and customers alike and genuinely want to learn from the seller before he or she leaves the company. Most manufactured buyers will not ask for some of the extreme terms that financial buyers might ask for and they are easy to work with as the inevitable sales-related issues surface.

Manufactured buyers were around during the last super cycle but were not very active in our industry.

Inside a sale

My company helped to find a manufactured buyer for an industrial metal recycling firm that had $18 million in annual sales and net income of $1 million. The company’s earnings before interest, taxes, depreciation and amortization (EBITDA) was valued at $1.5 million. The seller also owned real estate under a separate limited liability company.

The deal was structured so that the seller received a consideration of five-times EBITDA, or $7.5 million, including inventory, finished goods and work in progress. The buyer put $1.5 million down and had a bank loan of $6 million.

Of the $7.5 million sale price, $1.5 million was held in escrow for 12 months as protection for the buyer against any breaches in warranties given by the seller.

The buyer also took a 15-year lease on the property at a charge of $100,000 per year.

The seller received a one-year salary of $150,000 to serve as a consultant during the transition.

Eighteen percent of the sale price was allocated to inventory and equipment, while 82 percent of the sale was allocated toward goodwill.

The net result of the deal described is that the seller received $7.25 million after the holdback was tapped for $250,000. However, the seller also received the $150,000 salary and another $1.5 million in rent. Almost all of these funds were taxed as capital gains because the goodwill allocation was so high. The rent became a good portion of what the seller needed to spend in retirement. He invested the $7.25 million, making roughly 5 percent for a total of $362,000 in earnings. These earnings plus the $100,000 in rent he received from the buyer totaled $462,000.

In a great coincidence, the $462,000 was almost equal to the net income of $500,000 the business had been making, and the seller no longer had vendor, customer or employee issues to deal with, he only had to enjoy his retirement: a manufactured retirement.

Timothy B. Kneen is the founder of Lumina Consulting, Parker, Colorado. More information on the company can be found at https://luminaconsults.com. Kneen can be contacted at tim@luminaconsults.com.