"How does a consolidator arrive at the value of a shop?"
— Clyde Wilkerson, owner, Wilkerson Body & Frame, Kokomo, Ind.
To answer this question, we must first define which type of consolidator you might be dealing with. Collision shop consolidators generally fall into one of two categories.
First, there’s the consolidator whose sole purpose in life is to operate collision shops. He generally buys other shops to obtain their customer base and increase his market share. Or he wants to buy your business to secure your location, employees or equipment.
Generally, this kind of consolidator is buying businesses locally or regionally and is targeting shops he believes have weaknesses — for example, owners nearing retirement who want to get out of the business or have poor sales results, disgruntled employees, etc.
These buyers are very familiar with this business and are usually very familiar with your business. You can expect them to offer a price based upon the hard assets the business owns in buildings and equipment, with little or no value placed upon the intangible assets a business possesses — like the customer base you’ve worked years to build or the excess cash (cash beyond your basic salary) the business provides.
Because these consolidators (predators) sense a weakness, they’re simply trying to exploit that perceived weakness. In the last five years, I’ve only encountered a handful of people who fit this type of consolidator profile. And they were doing very well for themselves because they primarily bought other shop’s assets (usually at a depreciated value), combined them with their current assets and utilized this larger asset base to gain a larger market share.
This isn’t the type of consolidator the industry is dealing with (thank goodness).
The Venture Capitalists
The consolidators everyone attends special meetings about and secretly hopes will buy them out are the ones using venture capital. Their plan is to buy enough shops to build a national, or at least a strong regional, collision repair brand. These companies use venture capital to buy strategically located shops — those that already have a good share of the collision business in a select market or those that, when combined with other strategically located shops, will have a large share of the business in that market. There’s also a reason why they buy shops instead of build shops, which you’ll understand as I go on.
These consolidators are paying as much as 10 times the amount the predator would pay. Of course, that huge offer comes with some strings attached.
Make Me an Offer
Consolidators use what financial analysts and bankers refer to as "adjusted cash flow" to determine the value of a business they want to purchase. Adjusted cash flow is determined by combining the business’ profits, the owner’s compensation (including perks like free vacations, credit cards, vehicles, etc.) and depreciation (remember, depreciation is a non-cash expense). The equation looks like this:
Business Profits + Owners Compensation + Depreciation = Cash Flow
Then they subtract from the cash flow the expenses they’ll have to spend for a professional manager.
Cash Flow – Manager’s Salary = Adjusted Cash Flow
I’m sure business brokers, accountants and lawyers can come up with hundreds of twists to this simple formula, so let’s just assume this is the "basic" model of business valuation.
Once the adjusted cash flow of the business is determined, the next step is to place a value on the actual cash flow the business is generating. We recommend that our clients calculate the value of this cash flow as if it were invested in another venture (such as the stock market). I’m not sure what the stock market is paying to investors today, but let’s assume, on average, it pays a 16 percent return rate. Since we’re making up numbers here, let’s also assume your business has an adjusted cash flow of $100,000.
To calculate the investment value of this money, we’d divide the adjusted cash flow by the rate of return.
$100,000 Adjusted Cash Flow ÷ .16 Rate of Return = $625,000 Investment Value
Next, we convert the investment value into a multiple of the cash flow.
$125,000 Investment Value ÷ $100,000 Cash Flow = 6.25 Multiplier
This formula tells me that if I took the $100,000 my collision shop is generating each year and put it in the stock market instead of back into the business, that investment would earn me $625,000. Thus, based upon the adjusted cash flow method, the value of your business today is $625,000.
Adjusted Cash Flow x Business Multiple = Business Value
Before you spend that money, don’t forget you’ll have to pay some bills first. The seller would be responsible to turn over a debt-free company. This means we must then subtract the total liabilities of the business from the business value to determine owner’s equity.
Business Value – Total Liabilities = Owners Equity
Let’s assume this business has $250,000 worth of liabilities.
$625,000 Business Value – $250,000 Business Liabilities = $375,000 Owners Equity
The real kicker in this buying/selling dance is agreeing on a multiplier for the cash flow. We see companies trading on the stock exchange for as little as one times cash flow and as much as 150 times cash flow. Of the collision shop sales I’ve seen, most are using a multiplier of four to eight times adjusted cash flow. The pattern appears to be to pay a high multiple for the "bell cow" shop and then try to negotiate a much lower multiple for all the other shops.
What’s a "bell cow" shop? If I’m a consolidator and I want to buy 40 percent of the body shop business in, let’s say, Peoria, I would pay top dollar for the largest shop in town. Then, I’d get this shop owner, my "bell cow," to brag to everyone in town about his huge selling price. If I play my cards right, this tactic should get every other shop owner in Peoria to call me. Of course, I’d have to see their books before I could make them a similar offer.
Doing this accomplishes two things. First, it gives a consolidator access to a financial composite of the entire market. Second, it puts him in a position to drag the negotiations. If I push the right buttons until I get the shop owners I want (need) to buy so frustrated and confused, eventually, they’ll accept a lower offer for their businesses.
The net effect is that the consolidator who needs five shops in a market to make his business plan work starts out with a target multiple of five. He buys the first one at eight, the second at six and the remaining three at four. His average multiplier for the entire market is then 5.25.
Before you start thinking you can somehow manage to negotiate yourself a multiplier of 30 times cash flow, consider this: General Motors’ stock trades at somewhere around six to eight times its earnings. I believe at one time Yahoo traded somewhere around 1,500 times its earnings. Unfortunately for you, the body repair business is much more akin to GM’s business than Yahoo’s.
Where’s My Money?
There’s another catch here: Don’t expect to get all your money up front. Usually, the bell cows are the only ones who even have a chance of getting paid in cash, and very few of them actually get cash.
The general rule of thumb is to pay around 10 percent of the purchase price in cash and the remainder in stock in the consolidated company. This will have a ton of restrictions, such as being unable to sell it for a period of two to five years, or it being a non-voting stock that you or your lawyers have never heard of.
Before you start thinking how great it would be to be a "major" stockholder in the world’s largest collision repair company, consider this: You’ll be buying that stock with the business you currently own and control. You’ll be investing your life’s work in a venture that, in most cases, is nothing more than a very well-written business plan –– a plan with very few real assets other than a large amount of money in the checking account placed there by a venture capitalist, who expects to earn a huge return on his investment.
If you’ve figured out how this deal works, you may move to the head of the class. If you haven’t, let me explain. The consolidator doesn’t buy you; you buy into the consolidator. You trade your business for stock in their business. With this type of investment, a consolidator can take $10 million of investment capital, and by only paying out 10 percent up front, can leverage this $10 million investment into a $100 million company or more. Of course, that’s assuming everything in their business plan goes the way it’s supposed to. But there’s a law about plans. Do you remember "Murphy’s Law"? Anything that can go wrong will go wrong. I subscribe to "O’Brien’s Law," which is that Murphy was an optimist.
Let’s see if we can figure out what’s in this for the consolidators and venture capitalists. They buy your company for 10 percent down and stock in their company — stock that can’t be traded or sold for five years or longer. During this period, they utilize your assets and set aside profits from the business to buy back your stock. At the end of the period, you get your money and they get the business.
Please don’t misunderstand. I’m not saying this isn’t a good deal. I’m merely pointing out how this type of consolidation works.
The Tale of Two Sales
Let me share two tales of shop owners who’ve sold to consolidators:
The first one negotiated an all-cash offer and walked away with several million dollars. Today, he’s the most frustrated person you’ll ever meet. He bought a big house, some nice cars, invested the rest and now has absolutely nothing to do. He signed a no-compete clause for the collision industry, but running collision shops is his passion in life. The money was his scorecard and now that he’s won the game, he doesn’t have any passion left. I don’t like being around him; he’s rich and miserable.
Another shop owner (not in the collision business but another auto-related business) accepted 10 percent cash and stock for his company. He also elected to stay on and become a regional manager, supervising four locations for the company. At the time of the sale, the stock was valued at $26 per share. It’s since gone public and, today, the stock is trading at only $9 per share. His five years of hard work has resulted in a 65 percent loss of value in his investment. This person has no choice but to stick with it and try to rebuild the value of his investment.
Who knows whether it would’ve been any different had he decided not to sell. And, with the stock market being so fickle, the stock could go to $100 per share tomorrow.
The bottom line is, be sure you know what you’re getting into when you consider selling to any consolidator. Weigh your options and examine the offer carefully. Your future depends on it.
Writer Larry Edwards, C.M.C., is a certified management consultant and president of Edwards & Associates Consulting, Inc. in Harrisburg, N.C. Edwards & Associates specializes in shop management consulting for dealerships and independent shops. You can reach Edwards at (800) 979-9904 or e-mail him at ([email protected]).
I can’t tell you whether or not you’re getting a good offer or even if the deal is fair. You have to determine that yourself. I can, however, give you what I call Larry’s rules for buy/sell negotiations:
Rule No. 1 Never show your financial statement to anyone who isn’t willing to pay to see your financials.
Rule No. 2 Make sure everyone agrees this fee is only refundable when a purchase is made. Otherwise, you keep the money for your time efforts and for the knowledge your financials will provide the prospective buyer.
Rule No. 3 The multiplier must be equal to the real estate value increases in your market over the last five years.
Rule No. 4 Get as much cash up front as you can.
Rule No. 5 If they want you to stay on (most consolidators do), make sure your employment agreement is for a guaranteed fixed term.
Rule No. 6 Don’t take stock in the consolidator’s company until you have your accountants evaluate their financial reports. Remember, you’re investing in them; you need a third-party professional to tell you this is a good investment.
Rule No. 7 Make sure you understand all the restrictions that come with the stock.
Rule No. 8 Make sure you and your family can live with the stock restrictions.
Rule No. 9 Get a professional — an attorney, a stock specialist or a consultant — to review the plan before you commit.
Rule No. 10 Conduct all negotiations outside of your business. No matter how your negotiations go, your business will need to continue when everything is said and done.