What happens after you sell your business? You might be (happily) surprised to find out. Most people, when selling their business, immediately focus on how much they can put in their pocket at the time of sale. What they often miss is how they might improve their financial position after the sale. This is often called “The second bite of the apple.” In a successful private equity transaction, it is not uncommon that the “second bite” is of equal value to the owner as the first transaction.
But before we go there, let’s take look at a real-life example of a bus company sale. We must add a caveat; the bus operator sold his business to a private equity group (PEG), not another bus operator. I explain why that’s critical in just a moment.
Valuing a bus company
The bus company in this example had good — not great — financials. The owner was prudent, kept his debt at reasonable levels and had decent profit margins. Overall, somewhat average as private bus companies go.
In developing what’s called an Opinion of Value, we collected the following items:
- The past three years of financials.
- Trailing twelve months financials. For example, if the current month is July, we looked at financials from July of the previous year through June of the current year.
- The list of equipment. This is essentially the equipment list with insured vales attached to your insurance policy.
To calculate company value, we began with EBITDA — earnings before interest, taxes, depreciation and amortization. Then we made adjustments/add backs for expenses such as family salaries, one-time expenses (e.g. ELDs), discretionary expenses such as association membership (quick disclaimer here, we don’t believe UMA membership is discretionary. It’s a must have) as well as other items.
When all is said and done, our client’s adjusted (or normalized, as the CPAs would say), EBITDA came out to about $2.5 million, which isn’t bad, wouldn’t you say? When you factor in a multiples of 4.5, the company’s value came out to $11.25 million ( $2.5M x 4.5 = 11.25M). And, as was said earlier, this operator was wise enough to keep his debt as reasonable levels. In this case, he had to satisfy about $2 million in outstanding debt. This meant he would pocket $9.25M ($11.25 – $2.0 debt $9.25M) before tax by selling 100% of his business to a private equity group.
What’s important to the buyer, a Private Equity Group (PEG)
First, you should know that PEGs are not interested in just maintaining and operating a bus company. They want to grow their investment. Recognizing that a bunch of blue-suit, MBA types know little to nothing about running a bus company, PEGs will want to keep the bus company’s management team, put them under contract and pay each of the team members a very good salary to continue to run and expand the business. To keep most of the management team in place, the private equity group will encourage the owner(s) to stay on, at least for a certain period, and to encourage them to maintain some equity ownership in the business.
In our example, the owner elected to keep 20% ownership of the business, pocket the other 80% for himself and his family, and, in the process, leave behind all the risks, expenses and liability of ownership. For example, if the operator needed to buy a new bus(s) to go after a new contract, the PEG would provide the funding. The days of personal guarantees are history.
After the sale – growing the dompany
First, you should know PEGs are beholden to their investors who expect them to grow whatever investment they make with their money. Otherwise, what’s the point? These investors can always put their money into mutual funds, bonds, stocks or any other type of investment instrument. But instead, they provide their funds to a private equity group to invest in companies with growth potential.
As everyone knows there are basically two ways to grow a company;
- First, organically. You expand into new markets, capture new contracts, grow your customer base, etc.
- The second way, of course, is through acquisitions, by buying other bus companies in their market and assimilating those new entities into the business. And, with each approach, the PEG would provide the funding. They are eager to do this because they have funds that need to be employed rather than sit around in some interest-bearing instrument.
While continued organic growth is always important to a PEG’s investors, the latter becomes the preferred strategy since it’s typically a faster way to grow their investment and a process they have been through many times.
Three- to five-year window
So let’s take a look at what’s happened to this particular bus owner who, along with his team, continued to operate his business and acquire other smaller bus companies in their market. By bringing the new transactions into his company, he was able to reduce his overall operating expenses, leverage the additional equipment, and expand into new markets and take advantage of access to new customer bases.
In a matter of a few years (three to five), the value of the 20% ownership he kept grew in value to almost as much as the 80% he pocketed when he sold to the private equity group initially.
Here's how it works
To keep it simple, let’s say the company sold for $5M originally. As such, the owner held onto 20% equity or $1M of equity, and he pocketed the remaining $4M at close. Over the next three to five years, the owner and his management team worked to grow the company through internal growth and acquisitions thanks to the financial backing from the PEG. Over those several years, the value of the grew to $18 million from the original $5 million. Thus, the value of the owners 20% holding also increased to $3.6M (20% x $18M = $3.6M). Almost the same amount he pocketed with the original sale.
So that is the second "bite at the apple"
Deciding to sell or bring in a partner (PEG) for your company is not always easy. Especially like most in this industry, an entire family is involved in that decision. In thinking through your decision, though, it’s important to know and understand all the options available to you. Keeping a small percentage of equity can be an exciting and potentially very profitable way to improve your financial position and minimize all the headaches and risks of ownership.
Victor S. Parra is an adviser for Corporate Finance Associates.