Primary Source of Equity: Savings; other private investors
Opportunity Spotted: "I want a business where I can see real value. For instance, as the population ages there will be a greater need for products and services that help older people. That's going to create a demand for businesses in health care, for instance. As a buyer, you can see the trend and you can see real value."
H. Michael Stevens, 39
Career Highlights: IBM, 2 years; Summa Four Inc., a start-up telecommunications company, 7 years
Ideal Acquisition: Family-owned light manufacturing company, $3 million to $20 million in sales
Would Look At: Corporate subsidiaries
Willing To Pay: Three to six times pretax earnings, up to $20 million
Primary Source of Equity: Investment partnership
Opportunity Spotted: "Family-owned companies frequently haven't reached their potential. The owners have been taking a lot of money out; now they're getting on, and they don't want to risk their capital base to take the company to the next stage. They usually have good management. But they just don't have the horsepower to tackle that next step."
ARE SERVICE COMPANIES DIFFERENT?
Three years ago a $2-million telemarketing company might have been a long, tough sell for broker Bob Gurrola. After all, it was a service company, light on assets -- at least the kind that cast a shadow or comfort a banker -- but freighted with intangibles such as loyal customers, management strength, goodwill. The sort of company that, though profitable, doesn't store its value or find its financing in the usual places.
Nevertheless, this telemarketing firm kept Gurrola's phone ringing with calls from vice-presidents of IBM and Hewlett Packard. "I've got top-notch people earning $150,000 a year looking for the opportunity to run their own shows."
Until recently, some of those same buyers might have thumbed their noses at service businesses. Why the interest now? The low price of admission, for one. Service companies, because they are unencumbered by hard assets, might seem riskier but also come cheaper, typically selling for less than manufacturers with similar earnings. "Buyers are finding they can get the same amount on the bottom line as, say, a manufacturing company, but without tying their equity up in expensive capital equipment," explains Richard Green, president of National Business Search Inc., in Dallas.
The exodus of midlevel managers from big corporations has enlarged the pool of buyers and fueled demand. But changes in valuation practices and capital markets have made service businesses more salable.
"Valuation has become more sophisticated," notes Robert Reilly, a partner with Deloitte & Touche in Chicago. "We are learning to break out the value of a supplier relationship, a customer list, a favorable lease, the assets that are off the balance sheet."
Owners and appraisers insist that conventional book value isn't the measure of a service company's worth. So what is? "Strong historical cash flow," says Bill McClure, managing partner of Amerimark Capital Group, a merchant banking firm in Dallas. What buyers inevitably purchase is the company's future earnings. But profits promised don't sway many bankers.
How, then, are the deals financed? A more sophisticated capital market has emerged for small, closely held businesses that did not exist five years ago, say industry watchers. Regional merchant bankers and cash-flow lenders are more tolerant of softer assets. Money-center banks such as Citicorp or venture groups such as GE Capital have taken to financing some intangible assets. And now that merger mania is dead, even Merrill Lynch confesses to being "more willing to talk to companies doing under $10 million in sales," says Richard Hanson, a director of Merrill's financing and credit services, part of the business financial services group.
Despite the array of alternative lenders, loans for buying service companies are not easy to come by. Bob Scarlata, principal and owner of The March Group Inc., in Nashville, says that "demands a more realistic approach by the buyer and the seller. The owners know they'll have to carry most of the debt." Besides, owner financing is often the best way to win your asking price.
"The discount for an all-cash sale can be so steep -- as much as 50% -- that many sellers are unwilling to accept the price," says Jeff Jones, president of Certified Business Brokers, in Houston. A typical transaction will leave the seller carrying a note for two-thirds of the sale price. But some choose to carry the entire balance at a premium rate. "They see financing the business as a good return on investment," says C. J. Harris, whose firm, based in Greenville, N.C., specializes in brokering businesses.
While service sellers might realize a nice return on a business that never demanded much capital, they rarely walk away scot-free. The owner, often the company's most valuable asset, can expect to sign a noncompete covenant and probably an earn-out or employment agreement as part of the sale. In many transactions, a significant portion of the purchase price can be deferred and paid incrementally over the life of the seller's consulting or noncompete agreement. That not only minimizes the buyer's up-front costs but clearly defines and protects one of the business's major assets. And the cost of the seller's employment contract is tax deductible.
Given the time it takes to sell and transfer the business, smart sellers plan their exit one to three years in advance. "You don't have a lot of tangible assets,"' says David W. Brandenburg, who sold his computer dealership in the summer of 1989. "So you're selling the viability of the business and its growth. How can you guarantee that? By doing better each quarter." -- Anne Murphy
