It Figures Podcast: S4:E4 – The Art and Science of a Market Assessment

Speaker 1:

From Carr, Riggs, & Ingram, this is It Figures, the CRI Podcast, an accounting, advisory and industry-focused podcast for business and organization leaders, entrepreneurs, and anyone who is looking to go beyond the status quo.

Paul Evans:

Welcome to the IT Figures podcast. In this episode, we’re going to be covering the market assessment. This is CRI Capital Advisors. I’m Paul Evans. I will be moderating, but also I’m one of the partners here at Capital Advisors. And the focus is to help you determine the value of your business when you go to market. It’s so easy to feel like, “Well, I know what my business is worth and I know what I should get in the marketplace,” but there’s a lot more nuance to that. And so we’re going to be looking at five elements of an assessment today. But before we begin, I want to introduce those who’ll be with me today, Brandon Maddox, and also Joel Sikes. Brandon, tell us a little bit about yourself and your background.

Brandon Maddox:

My name’s Brandon Maddox and I’ve been with the firm going on almost 10 years now, and I am a partner with CRI Capital Advisors. In my former career I was a software engineer, so very process-oriented by nature. So my primary role in the firm is to manage the process that we’re taking our clients through from the time they want to start thinking about selling, and gathering all the information all the way through till the day of close.

Paul Evans:

Thanks, Joel.

Joel Sikes:

Hey, Paul. Thank you. My name’s Joel Sikes. I’m the partner in charge here for CRI Capital Advisors. I’ve been with the firm for about 13 years. Prior to that, I had a fairly diverse career in commercial banking, some of that was in healthcare. I was part of a couple of entrepreneurial endeavors. Landed with CRI Capital Advisors about 13 years ago and have really enjoyed helping clients of the firm talked through the process and ultimately execute the process of selling their business, whether that be toward retirement or just the next phase of growth in their business.

Paul Evans:

Again, I’m Paul Evans, also one of the partners here. And I founded the original company that merged in 2010. I stepped away, came back in 2017 and we’ve enjoyed working together and we love being the mergers and acquisitions arm of Carr, Riggs & Ingram. So as we begin thinking about assessments, Brandon, why is a market assessment even important?

Brandon Maddox:

Yeah, as I was thinking about this question, I think the key piece for me and what it really does for us, and also really for a business owner, is it gives them some context. It’s one thing to think about, “Hey, one day in the future I’ll sell my business,” and you can dream about what it might look like and all the ways it would go and the value that your company will bring, but you really don’t know until you have somebody who is familiar with what the market is doing, come to you and look at your business, do a deep dive and say, “Okay, based on what your specific business is and based on the specific market conditions that we’re looking at now, this is actually what you could get for your business.”

So it really gives a business owner just some really good context to put that whole discussion in their mind into. Because really, a lot of business owners, they have friends who have also sold businesses. And time and time again we hear the story, “Oh, well, my buddy sold a business and they were able to get 10X for that business.”

“Okay, well, that’s great. Do you have the same kind of business that your friend has?”

So it just resets that a little bit for the business owner and allows them to see their business through the eyes of what a potential acquisition in the current market could look like.

Paul Evans:

That’s so critical to be able to have that perspective and to be able to have the right expectation going into a deal, so that you don’t get disappointed and hopefully you would get elated. However, there’s a big difference between a market assessment and some people often feel like they need a business valuation. So Joel, what’s the difference between those two?

Joel Sikes:

That’s a great question and we encounter this question a lot, and I can say that here at CRI, we have quite a few very skilled credentialed business valuation experts. And so when it comes to the difference between a business valuation and a market assessment, a business valuation is a very, very technical exercise governed by some very strict guidelines and it’s to be used in some very specific purposes. So for example, if you were giving ownership shares of your business to a relative or to a valued employee, you’ve got to think about the tax implications of that gift, and maybe even a gift tax return at some point. There’s really got to be a very technical valuation performed to get those figures just right.

If you’re forming up a partnership agreement or if in the unfortunate situation of a partnership dissolution or a dissolution of marriage proceeding or some sort of IRS or tax court proceeding, you’re going to want a credentialed valuation expert to provide that valuation analysis. Air quotes, ours is not going to hold up in court. So the assessment is more about what is your company going to sell for in the current market environment. I would not be able to sit on a witness stand and provide expert testimony that my valuation is exactly correct according to all the IRS standards, all the accounting standards. What we can do is assure our clients that the estimate of value or the assessment of value that we give in our market assessment is extremely close to the value you can expect to receive when you take your company to market.

So one is very, very technical, governed by very, very strict guidelines. The other truly is a comparison of your company to other companies into the market to peg or approximately peg the eventual selling price for the business.

Paul Evans:

That’s such an important distinction so that people understand when they’re receiving that number of they’re going to market, this is the number that they most likely will hear. And I will say that our method that we use has a very high rate. We are over 90% accurate when we say, “This is the number you’re most likely to hear when you go to market.” And it’s because we have a specific process. Now, we were talking to a client just a couple of weeks ago and they were told that their multiple would be somewhere between a four and a nine. Well, that spread is just too large. You need to get it within a point minimum, but hopefully within a half a point, so that the expectations can be set correctly. But that’s not an accident. It doesn’t just happen. It’s because we have this process and there are four elements to a successful market assessment. And number one, and we’ll run through all five in this podcast, number one is financials. Joel talked to us about the importance of financials.

Joel Sikes:

Well, that’s kind of where it all starts, and there are many ways to approach the valuation or the assessment of the value of a business. We tend to rely somewhat on the multiple of EBITDA method, although that’s just one link in this chain. To get to the right EBITDA figure, you’ve got to have extremely reliable financials, you’ve got to cut all the noise out of those financials. Often, we see clients come to us, their bookkeeping is great, there’s nothing wrong with that. There’s just a lot of stuff in there that a new owner, maybe a corporate owner or a private equity owner, they’re not going to have. So think about things like running vehicles through the company that maybe are a legitimate write-off for the business, but they also really function more as personal vehicles. Is that going to continue under new ownership?

There may be some discretionary travel that is legitimately categorized as business travel, but is a new owner, a corporate owner or private equity owner going to include that in their expenses? So a great foundation on financial statements, as well as normalizing those financial statements to be able to present those in a way to say to the acquirer, “Hey, this is what this company looks like for you. I’ve run it as a closely-held company. I’ve done everything by the book. Everything I’ve done is legitimate. But here’s how these financials would look recast or normalize toward the way that you’re probably going to run it after the transaction.”

Paul Evans:

So the assessment begins with the financials that need to be in great condition. We are fortunate to be part of an incredible firm that serves its clients well, and to be able to help us receive those financials in that type of condition and certainly they could assist you as well. Second step after financials, is we look at seven factors of value, seven factors. And we’re not going to spend any time on these, I simply want to name them. We have resources at criadv.com related to this, and also our LinkedIn account as well. But the seven factors are, number one, predictable profits. Number two, tremendous team. Number three, which we’ve already covered, fortified financials. Number four, driven diversification. Number five, recurring revenue. Number six, gauged growth. And number seven, strong systems.

So as you see, there’s a lot of different elements, a lot of different factors that go into value. It’s not easy enough to be able to say, “Here’s what the net income is,” or, “Here’s the adjusted EBITDA. Give me my multiple. Let me go to the house.” But instead, the strength of your company is determined by the amount of risk that the buyer is going to take on. And those seven factors, and every company won’t have all seven, but the more of the seven that you have that are in great condition and are strong, it allows you to have a little bit of lift in that value and it brings a lot of confidence to the table, so that the buyer does not feel like they’re going to have to do a lot of heavy lifting after the transaction, but instead they feel confident right out of the gate in the transaction.

So we look at those seven factors and factor that into the equation as well. It’s not simply a science piece. There’s also the art piece to a proper market assessment. And number three is the multiple. There is a lot of activity around multiples and talks and people usually come to the table saying they’ve heard the multiple is X, and yet that’s not quite as easy as it is. Brandon, how do we determine what a multiple is and what difference does it make?

Brandon Maddox:

Yeah, it makes all the difference in the world because as Joel mentioned earlier, typically deals are trading on a multiple of EBITDA. So you spend all this work getting to a really defensible position as it relates to your adjusted EBITDA, but then that gets multiplied by something. And it’s so true, Paul, you mentioned we’ll have business owners come to us and they’re talking about the multiple. “Oh, I heard the multiple is 5X,” or 10 x or whatever it is. Well, that might be the multiple for one specific industry, probably the industry that their friend’s company sold into. But those multiples become so specific depending on what type of industry you’re in and even the subset or the niche in that industry.

For instance, you could have a manufacturing company. You might have one company that is focused on manufacturing high-precision components for medical devices, for instance. That manufacturing facility or company may trade for a higher multiple than if you had a company that was doing something of a less precision nature, something that was just a commodity, that they were just kind of pumping out everything all the same, just kind of in an assembly line fashion. It’s not going to be an apples-to-apples to comparison. So even if you have somebody who has sold a manufacturing company and maybe it got a 7X multiple, that doesn’t automatically mean that all manufacturing companies sell for a 7X multiple.

And there’s a lot of some tools that we use to be able to help us slice and dice that whole discussion about multiples down to a really specific narrow range to where we can say, “Okay, for this specific business in this specific very niche section of, call it manufacturing for instance, this is going to be the multiple range.” And it’s not going to be a wide multiple range. It’s going to be a relatively small one, and it’s based on transactions that have actually happened. It’s not theoretical, it’s not maybe, “Hey, we really think this is going to be the multiple when you go to market.”

No, it’s based on what companies are actually selling for. And it’s key to keep that in mind when we’re talking about multiples, when we’re looking at, okay, what did this other company sell for? Okay, let’s make sure it’s apples-to-apples. Let’s like make sure it’s the same type of company. Let’s make sure it’s even the same size company. Depending on the size of the company, multiples can vary widely. A smaller company typically is going to trade for a smaller multiple. A larger company as far as net income goes, is typically going to trade for a higher multiple. So there’s a lot of nuance that goes into figuring out what, quote, unquote, the multiple is for any particular company.

Paul Evans:

Thanks, Brandon. Yeah, it’s so easy to think, “Oh, I’ve got the answer,” but it takes a lot of work, a lot of research. Number one was financials. Number two, the seven factors. Number three, multiples. And number four is comps. Joel, when it comes to figuring out the assessment piece, how important are looking at comps in the same arena?

Joel Sikes:

Yeah, I think it’s really important. It’s kind of like when you buy or sell a home, you want to know what similar properties are selling for or being acquired for. Similar, but this is even a little bit more complicated than that. There are so many nuances to the types of company that we deal with. So it does take a really deep analytical dive into past transactions, and really what’s going on in the market right now. So we may find a really great comparable transaction that seems to check all the boxes that matches the company that we are working with, the geography, the type of company, they’re manufacturing a really similar product, their end user markets are the same, their supply chain is relatively the same. All that could just be really lined up perfectly. But that perfect comp could be four years old, and it may be totally irrelevant now because the market may have shifted by now.

So it’s a combination of making sure we’re looking at a truly comparable transaction or set of transactions, but also considering, hey, is that still true? Are the multiples that they achieved, are they better or worse now? Has the economy changed? Have interest rates changed? Has that particular market segment changed? Is there some sort of regulatory change or threatened regulatory change that may impact that market? So it’s more than just looking back at transactions for the past 10 years and saying, “Hey, these are kind of similar.” You really have to dial in closely on a true comparable transaction that is currently relevant to the client that we’re working with.

And so we are fortunate here at CRI Capital Advisors to have some pretty robust tools that we can go to, so that we can see who’s acquiring, why they acquired. We can piece together a strategy just looking at the companies an individual acquirer has acquired over the past couple of years. We can say, “Okay, they’re making a really strong move in this particular sub-sector of that industry,” so we know that they may be a premium buyer because they’re really focused on that particular slice of the industry. So we want to be aware of the acquirer’s personality. We sometimes hear the term, “Well, we’re a value investor.” And to us, that means that they’re probably not going to make the highest offer. They want to buy at a value price, and just allow the company to grow somewhat naturally over time.

Whereas a premium buyer or an outlier buyer, they may already be in the space or they may have a really aggressive roll-up strategy for this particular industry sector, and they’re ready to just pour resources into these companies that they’re acquiring, so they can afford to pay more because they’re committed and properly resourced to achieving a 4 or 5X multiple of what they bought the company for. Then they may buy a company for $20 million, and the exit target for them may be 100 million, and they’re committed to doing what it takes to get there. So we have to think about the type buyer and the buyer’s personality as well.

And also we’re looking at is this an experienced acquirer? Are they doing a lot of transactions? And just a quick little note here, we are in close contact with an acquirer, who they buy companies that manufacture parts that support the airline industry, and that sounds easy enough, but when you peel the layers back just a little bit, you realize they’re only buying manufacturers of aircraft parts that are replaceable. It’s the wear parts. If our client makes a part that goes into an airplane and it’s intended to last for the life of that aircraft, this buyer’s not going to be interested in that. They’re going to be interested in the things on aircraft that wear out or that have to be replaced at certain intervals. So getting to know the buyers, getting to understand their position in the market and their attitude toward valuation is a critical part to finding true comparable transactions.

Paul Evans:

Even that component, there’s so much complexity there. When I said comps, most people thought, “Oh, well, they’re just pulling out a sheet to see what’s taking place in the market, and just using some quick and easy aspect,” and yet there is a lot of nuance that goes in even to the comparables. So that was number four.

Number five is market sounding. And with this, we go out to the market, we go out to the buyers. Even though this is for an assessment, we’re having conversations with groups that we know are active within that particular industry. We certainly do not mention the company, we do not mention geography, anything that would give the company away. We simply want to have a discussion to find out how hungry, what’s the appetite of the current market. And also, to see where the group is in their finances, to see if they were a little bit more aggressive or they pulled back, or are they one of these value or discount buyers.

So we listen to all of that. Now we know that they’re not going to tell us exactly what they would pay for the company, but we are able to listen to things that are going to give us clues to recognize if there’s a valuable position that will up the value just a little bit on the multiple side because we can tell that they would be really excited to have this type of company in the marketplace. So when it comes time for someone to get a market assessment, Brandon, when should this occur? Should they wait till right when they’re ready to go to market or what’s the best time?

Brandon Maddox:

No, I mean, it’s always good to be prepared ahead of time. So I would say when to do a market assessment, it’s when you start thinking about maybe one day selling your business. And even if that’s, “Hey, maybe in five years I’d love to sell my business,” or, “Maybe in three years,” or, “I’m not doing that anytime soon.” If you’re wondering, “I wonder what my business is worth,” that’s a great time to do it. Because more often than not, what we find is we’ll do a market assessment for someone and then they could be pleasantly surprised. “I had no idea that the market conditions were that good. Maybe I want to move my plans up. Maybe I’ll push that up a little bit. Maybe instead of waiting three years, maybe I’ll get ready and we’ll do this next year.”

So I think it’s really when that conversation starts coming up in the business owner’s mind, it’s really just a good idea to just have that check to just like I said before, have that context to understand. And maybe, we do the market assessment, it comes back low and the business owner is disappointed and says, “Wow, I really thought I would be able to get more than that in the market.” What we can do at that point is say, “Okay, yeah, you would’ve gotten more if you were able to tweak certain things in your business. Maybe it’s a growth plan that you need to implement that they’ve been sitting on for a while.” Maybe there’s some other factors, like the ones that Paul mentioned, that they could improve on that would increase the value overall. But it lets them know kind of where they’re at as opposed to just thinking, “Okay, one day I’ll sell my business and it’ll sell for an amazing amount of money.” Well, maybe it will, but you really never know until you have the assessment done. So when they start having that conversation with themselves in their minds, that’s definitely a great time to start.

Paul Evans:

Excellent. Joel, why is it important to even use a M&A professional for this type of work? Why use CRI Capital Advisors, or a similar firm, for this instead of just turning to anybody in the financial field to get this done?

Joel Sikes:

Yeah, that’s a great question. And of course, this is what we do every day. So I think just the experience we can bring to the table is just a huge factor. But business owners can be brilliant business people, but they may not live in this M&A world. So I think number one, just the experience, the exposure, you may be fantastic at your business, and one thing we are really respectful of is just the amount of knowledge that our clients bring to the table. We don’t ever go in telling a company, “Hey, here’s how you should run this,” or, “Hey, here’s how you should do that,” but we do really know the transaction arena. We do really know the transaction process. Even if you’re a great smart business owner, you’re going to encounter some challenges trying to navigate this process on your own.

So there’s just an experience piece there that we come along and add another member to your team as a business owner with just some added experience in the area. Once you’re into the process, if you have a business of a significant size, you’re very likely to be dealing with large corporations or sophisticated professional investors who do this all day, every day for a living. They’re often investing other people’s money, so there’s a fiduciary responsibility on their part. They are going to put our client and that company through the ringer, and they’re going to bring a virtual wall of flesh to the table with lawyers, and accountants, and consultants, and analysts of all types. We can help navigate that. We’re an extension of our client’s team just to help navigate a very detailed, very arduous process. It’s very, very rewarding at the end, but we feel very, very strongly that the clients of CRI deserve representation in a process like this.

Paul Evans:

Wow. Perfect. Perfect place to end. Joel, Brandon, thank you so much for your time today, and we continue to be open for opportunities. Those of you who are looking to get a market assessment done, feel free to reach out. You can email us at [email protected] or visit us online, criadv.com, or on LinkedIn. We really appreciate you coming out and listening to IT Figures today. The IT Figures podcast is always hosted and sponsored by CRI CPAs, Carr, Riggs & Ingram, and you can visit them online at cricpa.com, like them and follow them on social media.

Speaker 1:

If you want more CRI Insights or are interested in learning about our firm, please visit our website at cricpa.com. Thanks for listening to this episode of It Figures, the CRI Podcast. You can subscribe to It Figures on iTunes, Spotify, or wherever you prefer to listen to your podcasts. If you liked to what you heard today, please leave us a review.