How to Maximize the Value When Selling Your Management Company

Transcription

1 WHITE PAPER How to Maximize the Value When Selling Your Management Company INSIDE THIS REPORT Rational for Selling Management Company Valuation Acquisition Deal Structure Tips to Optimize Your Exit Value Other Considerations

2 RATIONALE FOR SELLING INTRODUCTION Selling a business can be a very time- consuming, trying, and emotional process for owners who have invested blood, sweat, and tears building their firms. And sellers even of similar sized firms may experience vastly different outcomes. A Tale of Two Management Companies For illustrative purposes, we will use two fictitious management companies: both with $2 million in Revenue, but with vastly different outcomes. Jane sold her management company for $1.6 million, while Jill only received $160k for her firm. Our valuation examples below will illustrate the reasons for the marked difference. The community association management industry has 5,000 to 7,000 companies, most with owners near the end of their careers that are facing the decision of when to exit and how to maximize the value of decades of effort. There are only a handful of firms on the other side of the table with the experience and resources to buy a management company. The exit process and the value a seller receives is largely in the seller s control and should receive as much strategic focus as possible in order to experience a good outcome. In this article, we will explain the typical rationale for selling, how firms are valued, typical deal structure, and several tips on how to optimize your inevitable exit. While there are various ways for owners to achieve the following goals without selling their business, owners should seriously consider an exit when one of the following situations has taken a higher priority than business as usual : Wealth Diversification and Estate Planning The majority of the wealth of business owners is typically tied up in their illiquid, private company and a frequent reason for selling all or part of a business is to unlock and diversify that value to protect against a potential market or business change that could adversely affect the value the owner worked so hard to build. Personal Inflection Point Over time an owner s goals may change to the extent that they want to exit for family reasons, to retire, to accommodate their health, to try something else, or to spend time on charitable causes. In these cases they have come to value their time more than the incremental financial rewards gained by continuing to operate their business. Business Inflection Point The business demands, capital requirements, risk profile, or competitive context may change to the extent that the owner does not want to shoulder the additional risk of taking their business to the next level. Market Timing Market conditions may dictate a seller s readiness to sell. For example, many management firm owners were prepared to sell several years ago, but they put the sale process on hold to stabilize Revenue and Earnings when the real estate market turned down. Although the timing may not be ideal in terms of valuation, the long, slow climb to previous highs may take far longer that anticipated. 1

3 MANAGEMENT COMPANY VALUATION One of the most sensitive parts of the exit process is usually the valuation of the business. Sellers will often feel their company is much more valuable than the market would indicate. Sometimes sellers will have a certain price they want, while other times their expectation was set by the price fetched by a friend s business when they sold. Much of this expectation gap has to do with the perceived value of the business by the owner, but part of the issue is a lack of understanding of the valuation process. There is a fairly standard market value for management firms based upon our analysis of scores of acquisitions, including the deals we ve completed. Management companies are usually valued using the following three primary steps: 1) determine the enterprise value by using industry comparables, 2) determine the equity value by using standard formulas, and 3) determine any adjustments in the company value or deal structure. Enterprise Value This valuation is most often measured in terms of Enterprise Value to cash earnings, with cash earnings expressed as EBITDA (earnings before interest, taxes, depreciation, and amortization). Total EBITDA is measured on the basis of the average of recent years or commonly, the most recent twelve months of the company s operational history (known as Last Twelve Months (LTM) or Trailing Twelve Months (TTM)). Adjustments may be made to EBITDA for above- market compensation or other expenses that would not be part of the acquired business. The overall Enterprise Value is usually expressed as a multiple of TTM EBITDA (or Adjusted EBITDA as appropriate). Community Association management firms are often valued along the following lines in terms of Enterprise Value with the EBITDA multiple increasing with the size of the firm: Firms with less than $1 million in Revenue: 3x 4x TTM EBITDA Firms with $1 million to $10 million in Revenue: 5x TTM EBITDA Firms with >$10 million in Revenue: 6x TTM EBITDA or more Enterprise Value Example Jane Jill Total Revenue $2,000,000 $2,000,000 Total Expenses 1,785,000 1,950,000 Net Income 215,000 50,000 Add back Interest - 25,000 Add back Inc. Taxes 60,000 11,000 Add back Depreciation 15,000 12,500 Add back Amortization 7,500 7,500 Adjustments - - Adjusted EBITDA 297, ,000 Purchase Price Multiple 5.0 x 5.0 x Total Purchase Price $1,487,500 $530,000 Equity Value After determining the Enterprise Value, the next step in valuing a management firm is to calculate the Equity Value, which is the Enterprise Value less any debt, plus excess cash and cash equivalents. While Enterprise Value was the value of the entire enterprise, it is not the value that a seller gets paid upon a sale. The buyer will take on the debt or the seller will pay off the debt upon a sale transaction or some combination of both. Further, the buyer will keep the cash in the business or the seller will take the cash (above normal working capital requirements) out upon a sale transaction or some combination of both. Finally, the debt and any excess cash in the business are necessary adjustments to arrive at the 2

4 value of what the owner actually owns in the business (see the example below). Equity Value Example Jane Jill Total Enterprise Value $1,487,500 $530,000 Less Debt - 370,000 Add Excess Cash 112,500 - Total Equity Value $1,600,000 $160,000 Final Adjustments After determining the Equity Value, the last step involves the valuation or deal structure adjustments based on several other aspects of the business as viewed from the potential buyer s perspective (see the exhibit below). While Enterprise and Equity Value calculations were rather formulaic, more objective in nature, and primarily market- driven or financially- derived values, the final valuation and deal structure may feel more subjective in nature. The exhibit shows a few of the more typical adjustments. Further refinements to the Jane and Jill scenarios might include price premiums or discounts from the market rate of 5x TTM EBITDA as well as deal structure refinements. For example, if Jill s company was felt to be on the low end of these typical adjusters, her deal might be structured with less Cash at closing and more of the total purchase price subject to contingency payments or a clawback. ACQUISITION DEAL STRUCTURE The total purchase price of the Equity Value is usually paid in three different forms: Cash at Closing, Seller s Note, and/or Buyer s Equity within the industry standard parameters as follows: Cash at Closing While most sellers would of course prefer all of the deal value to be paid in Cash at the closing of the deal, most industry deals indicate that sellers receive between 25% and 50% of the total deal value. The amount of cash at closing usually directly correlates with the buyer s perceived risk and the final adjustments input discussed in the section above. In the example, Jane received 50% cash at closing because the buyer perceived it as a strong and stable business, while Jill only received 34% cash at closing to mitigate the buyer s concerns about the low earnings and customer churn. Seller s Note The amount not paid in Cash at Closing will usually be secured by a fully- amortized Seller Note with monthly or quarterly principal and interest payments and a term that is typically three and five years in length. Earnout A portion of the overall deal value may be subject to contingencies such as a bonus payment for achieving Revenue growth targets or less value due to higher than planned customer churn. 3

5 Normally Earnouts are based upon the first post- acquisition year of operations. In the fictitious example below, Jane s deal includes an upside Earnout that enables her to gain additional value (perhaps because she recently landed new developer business that may turn into above average Revenue growth) whereas Jill s deal has a downside contingency where she may get less value (perhaps she s been struggling with higher than normal customer losses and this structure mitigates the buyer s concerns). Deal Structure Example Jane Jill Total Equity Value $1,600,000 $160,000 Cash at Closing 800,000 55,000 Seller Note 800,000 55,000 Potential Earnout + 100,000 +/- 50,000 $1,600,000 $110,000 Total Potential to to Deal Value $1,700,000 $160,000 Buyer s Equity In some cases, sellers may be offered equity from the buyer as part of the deal value. If that is the case, it is incumbent upon the seller to perform an adequate level of due diligence on the buyer to insure the seller fully understands the valuation of the buyer and the risks involved in the buyer s equity. TIPS TO OPTIMIZE YOUR EXIT VALUE Much of the preparation for a successful sale is having a year or two of successful operations and the clear reporting that reflects that fact pattern of successful growth prior to going to market to sell the business. Buyers want to purchase successful firms and there will usually be much more buyer interest in companies that launch the sale process after thorough preparation and with a successful track record. Here are a few items to consider prior to taking a company to market: Plan for Taxes and Estate Selling a business will likely be the most significant financial event in a business owner s life that necessitates careful planning to maximize the after- tax proceeds of a sale. Tax and estate planning can be very complex and business owners should check in with their tax and estate planning team well in advance of a transaction. Clean Up Your Financials Few things are more critical than to clean up and clarify your financial reports to make them more readable and to present a more professional appearance. Sellers should consider the following: Reduce the Income Statement detail to a more summarized view rather than a laundry list of various vendors and expenses Remove or consolidate all personal debt, employee debt, and other personal peculiarities Clean up and verify all accruals Clean up, verify, and get up- to- date on all tax- related matters Collect, sell off, or write off overdue accounts receivable Get current on accounts payable Upgrade Your Financial Reporting Another critical financial factor is to ensure your statements conform to industry standards and Generally Accepted Accounting Principles (GAAP). Sellers are strongly urged to upgrade their financial reporting as necessary in preparation of a sale, including: Report in accordance with in full accrual accounting rather than 4

6 cash, modified cash, or modified accrual Publish a full set of statements (Income Statement, Balance Sheet, and Cash Flow) for the past three years and with monthly trend analysis Have your financial statements audited for the most recent completed year Succession Planning An additional critical element of selling your business is who is going to run the business after the sale. This means that if the owner wants to transition out of the business, a strong, autonomous management team must be ready to take the reins. Organize Your Operation Going through a sale process and the ensuing due diligence will be much easier if the business is well organized prior to embarking on the exit process. Credibility is either gained or lost depending on how quickly and easily a company can respond to prospective buyer requests for information in the final stages of closing a deal. Owners should consider the following ways to organize their overall operation: Create an electronic filing system of all key documents related to the company this will be required for the digital data room, so sellers can get a head start to reduce the information demand crunch later Create documentation of all intellectual property (patents, licenses, trademarks, etc.) the more intellectual property plays in the value of the company, the more critical it is to document all related information for the prospective buyer Clearly document all core processes buyers look for repeatable and scalable processes that are not dependent upon the owner to oversee or implement Put a written plan in place and rigorously track performance to keep company growth and profit- ability on an upward trend Analyze your competitive landscape and review where you fit strategically within your market Execute employment and non- compete agreements with key management team members where appropriate (without disclosing a potential sale until the ownership group is ready to do so) Clearly document all bonus and profit sharing programs and employee benefit programs Create a clear organization chart with roles and responsibilities Determine whether or not any related owned real estate is to be included most buyers will not want real estate Ensure all customer contracts are fully assignable non- assignable contracts make an asset sale very difficult to execute and introduces additional buyer risk Resolve and settle all legal disputes all disputes will need to be disclosed, so sellers should get them settled to reduce uncertainty Upgrade Your Operation Buyers look for quality businesses that show well and have all of the necessary pieces in place for continued success and growth. Sellers should consider the following prior to marketing their company if they are not already in place or if they are in need of a facelift: 5

7 Implement a credible customer relationship management system and process Refresh the company website Implement a strong social media and online presence Repair, upgrade, and clean up the office and other operational facilities (especially the reception area and main conference room where buyer meetings may be held) Assemble Your Deal Team Finding qualified and experienced advisors and partners is critical for ensuring the success of a sale. M&A attorneys and audit and tax advisors play important roles before, during, and after a sale transaction is executed. Tapping your deal team to assist with due diligence, regulatory approvals, and structuring complexities are important determinants of maximizing your exit. These professionals have deep and highly- specialized expertise with a narrow focus to help sellers achieve a clear objective in the shortest timeframe possible, while leveraging the management team s time and effort on a task that they may not have sufficient experience or relationships in order to effectively accomplish on their own. post- sale prior to engaging in a sale process. Post- Sale Integration Spend sufficient time with the buyer to consider the fit between the two companies and plan the transition, especially employee- related issues of compensation, benefits, leadership plan, and communication plan and the customer- related issues of communicating the rationale and impact of the sale. SUMMARY Although selling your management company can be daunting, choosing a buyer with integrity, capital, and deep deal experience can go a long way to streamline the process. RealManage would welcome the opportunity to have a confidential discussion of all the potential options to sell your management firm, seek an equity investment to grow your management firm, or forge a strategic growth alliance. OTHER CONSIDERATIONS Finally, there are a few other considers potential sellers should consider: Your go- forward role It is normal for sellers to stay on for at least a short period of time to help transition. The deeper and more skilled your existing management, the less the need to stay on for an extended period of time, but be prepared to discussed your interest in staying on 6

8 About RealManage History RealManage was founded in 2004 with the vision of transforming the HOA management industry with a superior service model with the best people, best technology, and best processes. From its launch in 2004, RealManage has maintained a sharp focus on creating a distinctive advantage with its significant investment in its world-class, proprietary software and best-practices services platform that has enabled the company to grow rapidly since its founding into one of the top management companies in the U.S. Contacting RealManage For more information or a confidential discussion about how you can partner with RealManage to sell your management firm, seek an equity investment to grow your management firm, or forge a strategic growth alliance, please contact us at: , partnering@realmanage.com, or visit our website at RealManage, LLC