Wednesday, August 2, 2017

Three Reasons Why M&A Advisors Are Worth the Cost

A 2016 study asked CEOs who had recently sold their businesses with the help of an investment banker whether their advisor added value.

For a full 100% of respondents, the answer was yes, with 69% reporting a “significant” impact.

Eighty-four percent of the owners achieved a final sale price equal to or higher than the initial estimate provided by the advisor.

With these kinds of outcomes, one would think hiring an advisor would be a no-brainer.

But many would-be sellers are skeptical of the cost of bringing in outside help. One reason for this is that Part of the problem is that the specific value-add of an advisor can be unclear until you actually start working on the process with him or her.

Here are three specific ways a good advisor will help you rethink your business to increase valuation and improve terms before a sale.

1) A good advisor will identify weak links in your management team

Everyone has blind spots. This is particularly true for founders who have run their companies for decades and built the business from the ground up. There are almost certainly processes that only you have institutional knowledge of, and there are probably management team members you hired years ago who aren’t equipped to handle the company’s current scale.

Both weak management teams and over-involved founders scream risk to potential buyers — leading to lower valuations and/or unfavorable terms (e.g., earnouts as opposed to all-cash deals). It’s easy for owners to understand this risk theoretically, but much harder to spot it in your own business. An advisor can provide the outside perspective CEOs need to identify these blind spots and execute on an action plan before bringing the company to market.

2) A good advisor finds ways to increase cash flow

After years of running a business a certain way, changing things up can be tough. An advisor will bring a fresh perspective and plenty of first-hand experience to help identify and implement quick wins.

At some level, increasing cash flow is simple. “It’s a diversified customer base. It’s recurring revenue. It’s looking for opportunities to increase productivity and reduce cost,” says Chris Schumann, Managing Director at BKD and a BKD Next Advisor. “As Warren Buffet said, you want to widen the moats. Figure out what your competitive advantage is, then exploit it.” Figure out what you do well, then double down on it.

But after years of running a business a certain way, it can be tough to a) identify these opportunities and b) implement the necessary changes. Often it requires making hard decisions that will impact your employees in very real ways (e.g., cutting an underperforming product line inevitably means cutting jobs) and force you to break out of comfortable routines. An advisor can help you sort out risk vs. reward and execute on any changes swiftly and diplomatically.

3) A good advisor will help you whip your financials into shape

“Financial foresight is essential,” says Schumann. “Is the owner running the business with the reporting necessary to allow them to demonstrate performance to a buyer? Owners need to look at their business as if they were going to buy it, because that’s when they see what it’s worth.”

You also need to think explicitly about the business narrative you’re presenting to potential buyers.

“You can’t just throw out numbers and say, ‘We did $25 million this year and we’re going to do $35 million next year,’” says Schumann. “You need to demonstrate at a bottom-up level what the keys drivers of profits are, and then present a forward look that’s based on those drivers. I’ve seen time and time again where a seller can convince a buyer to pay up a little based on this kind of data-driven, clearly articulated forecast. But you can’t even begin that conversation if you don’t have the granular view of the performance to start with. You have to have something to build on.” Depending on how diligent you’ve been with record-keeping and reporting to date, putting together this granular view can take a significant amount of time. Your advisor can take the lead here so that you can continue to focus on running your business.


Schumann says the most important figure buyers evaluate in a sale is usually trailing twelve months EBITDA, which means that you’ll want the business to be in prime shape at least a year before the transaction. Building the management team, reducing dependence, increasing cash flow, cleaning up financials — all of these issues take time to address.

If you’re considering an exit and/or hiring an advisor, it’s best to get started early: “36 months before the deal is ideal, and 24 months is okay,” says Schumann. “The more time we have, the more likely it is we can go for the gold in terms of growing value before the sale.”

(h/t Axial)

Friday, February 10, 2017

A BC Mayor's Open Letter to Her Fellow British Columbians About Pipelines

Fort St. John Mayor – Lori Ackerman

I would like to talk to you about energy, pipelines and our natural resources.

I am a mum and a grandma and I have lived in the north all my life. I am also the Mayor of Fort St. John – right smack in the middle of one of the world’s largest supplies of oil and gas. I live in a region surrounded by pipelines, wells, hydraulic fracturing (fracking) sites and canola and wheat fields. I have eaten the food we grow here and I drink our water. I understand what it takes to extract our natural resources and what it takes to protect our environment. I live it.

I don’t want to try to convince you of anything but I would like to share with you what I know to be true. I strongly encourage you to do some of your own research. Learn more than what you read in a tweet or a Facebook post. Where does the petroleum we all use every day come from? Canada has some of the largest petroleum resources in the world and yet Canada imports 634,000 barrels of crude oil from foreign countries every single day. That is $26 billion of oil imports every year that we could have supplied to ourselves.

That product arrives in tankers and is transported to where it needs to go by truck and train right through our communities. And yet we don’t want our own product to flow in pipelines to our communities for our own use or to our ports so we can export it? That just makes no sense at all to me. So let’s talk about pipelines. I know pipelines are a safe, cost-efficient means of oil and natural gas transportation and emit fewer greenhouse gases than alternate transportation methods.

Canada has 830,000 kilometers of pipelines. Three million barrels of crude oil is transported safely every single day. B.C. has over 43,000 kilometers of pipelines. If we took that oil out of the pipelines, we would need 4,200 rail cars to move it. How many of those cars would you like rolling through your community?

Between 2002 and 2015, 99.9995% of liquid was transported through our pipelines safely. You probably spill more when you fill up at the gas station. I understand you don’t want tankers floating down our beautiful B.C. coast. But did you know the USA has been shipping up to 600,000 barrels a day of crude from Alaska to the Puget Sound through the Salish Sea for the last 20 years? Did you know that B.C. has a Tanker Exclusion Zone that has been respected for years? That zone stipulates that full tankers must travel on the west side of the zone but those that are not transporting goods can stay inside the protective zone. Other than one natural gas pipeline, Vancouver Island receives all of their petroleum by barge every day.

I don’t remember ever hearing anyone complain about that. According to Transport Canada over 197,000 vessels arrived or departed from west coast ports in 2015-1,487 of them were tankers. 400,000 barrels of crude oil is safely transported off the B.C. coast every single day. Sooo…I think we are OK there. Emissions? 80% of the emissions associated with fossil fuels are generated in their combustion – not their extraction and transportation. If you want to do something about our reliance on fossil fuels then address the demand for them not the transportation of them. Change starts with consumers not industry.

A large part of the demand for fossil fuels in B.C. is transportation. 33% of our fossil fuels are used to operate cars, trucks, planes, trains and ferries. If we switched all of that over to electricity we would need not just one Site C dam but 15 of them. Which communities do you want to flood to provide the energy for your electric cars? Remember I live 7 km from Site C dam so I have a pretty good understanding of them.

I love this quote from Blair King, an environmental scientist and writer: “We live in a world where all the work we do to reduce our greenhouse gas emissions in B.C. can be undone with the flick of a pen in China or India. No matter what we do, those developing countries are going to get electrical power to their populations – if not with LNG, then with coal; and if not with B.C. LNG, then with lower-intensity LNG from one of our competitors. In both cases the end result is higher global GHG emissions than if B.C. LNG was used.”

He is telling us to look outside our province and see the impact we can have on GHGs on our planet. Our LNG is cleaner than the stuff already on the market because our regulations are tougher and we emit far less GHGs in our production than in other countries. Our natural gas industry is committed to continuous improvement.

I understand that you are concerned about safety. I am too. In Canada we have some of the strictest safety requirements in the world. Canada’s oil and gas producers are continuously improving the safety of their operations and transportation of their products. Emergency Response Plans are customized for each community, covering key areas such as public safety, protection of community infrastructure, and a clear plan of action with local emergency responders. And we have the B.C. Oil and Gas Commission to oversee B.C. projects and the National Energy Board oversees the larger multi-jurisdictional projects.

The Oil and Gas Commission is our provincial agency responsible for regulating oil and gas activities in British Columbia including exploration, development, pipeline transportation and reclamation. Core responsibilities include reviewing and assessing applications for proposed industry activities, engaging with First Nations, cooperating with partner agencies, and ensuring industry complies with provincial legislation and all regulatory requirements.

International delegations come to B.C., as world leaders, to learn how we have partnered environmental protection with resource extraction. I think the Oil and Gas Commission does a good job of protecting the interests of citizens. Many of you have concerns about the rights of our Indigenous Peoples. I will not speak for them but I will provide you with a quote from Stephen Buffalo, president and CEO of the Indian Resource Council: “I think industry is now willing to be a partner (with First Nations). They want to come with the First Nations together. We are depending on these pipelines for the success of the Canadian economy.” So let’s talk about the economy. B.C.’s energy sector offers some of the largest provincial economic opportunitiesin a generation. It is estimated that, in 2010, 11.2% of the provincial exports came from the natural resource sector.
That was over $21 billion worth. Canada’s oil and natural gas sector contributes $1.5 billion to the provincial government but it is estimated that it could go as high as $2.4 billion per year. This is money for health care, education and infrastructure. The resource sector is the foundational stone upon which the B.C. economy was built, and it is as important today as ever. 440,000 Canadians are employed because of the oil and gas sector. A recent study by Philip Cross, former chief economic analyst at Statistics Canada, shows the huge economic value of the natural resource industry in B.C., and in particular the Lower Mainland. The report demonstrates that over 55 percent of resource-related jobs and income (direct, indirect and induced) flow to the Lower Mainland.

This means those workers contribute to our economy by renting or buying homes, buying groceries, enjoying a quality life and shopping their local businesses. Let’s lead the world in resource extraction, continuous improvements and long term planning. Let’s be leaders in reliable and renewable energy development. Let’s support Canadian industry and stop buying foreign oil. Let’s grow our economy by meeting our domestic needs and exporting our abundant resources. Let’s live well now and in the future.

Thank you for taking the time to be an informed citizen.

Lori Ackerman
Mayor of the City of Fort St. John

(This letter originally appeared as a paid advertisement in the Vancouver Sun.)

Fossil Fuel Fictions vs. Fossil Fuel Facts

Fossil Fuel Fiction #1
We have the technology to replace fossil fuels with wind and solar energy.

Fossil Fuel Fact #1
Fossil fuels generate more than 65% of global electricity production. Despite the hundreds of billions of dollars invested, wind and solar provide only 1.5% of global power.

Fossil Fuel Fiction #2
Canada’s oil and gas industry increases global carbon emissions.

Fossil Fuel Fact #2

Canada is responsible for less than 4% of the 96 million barrels of daily world oil production. If our production were completely shut down, that 4% and the emissions associated with it would quickly be replaced by other countries. Moreover, carbon emissions from Alberta’s much-maligned oilsands make up a minuscule 0.15% of global emissions.

Fossil Fuel Fiction #3
Canada’s carbon tax will be part of a global emissions reduction effort.

Fossil Fuel Fact #3
While 111 countries at the November Marrakech climate change conference supported a proclamation calling for “the highest political commitment to combat climate change,” the real-world facts paint a far different picture.

Only countries with a combined global emission share of 17% have any intention of honouring that proclamation. And because none of those are significant trading partners, imposing a carbon tax to reduce Canada’s minuscule 1.6% of global emissions is simply economic hara-kiri.

Read more at Business Vancouver

Friday, January 6, 2017

Six Trends Proving Canada Needs More Natural Resource Development, Not Less

Somewhat related to our earlier post about trying to see the big picture...

The following comes from ResourceWorks:


These six 2017 trends prove Canada's future lies in more natural resources (not less)

That's the takeaway from this selection of charts from some of the country's leading economic minds.

They are drawn from the just-published annual collection of 75 economic charts from Maclean's magazine.

Natural resources are a major source of economic strength while central Canada continues to be hit by job losses in manufacturing. If it wasn't for the resource economy, it's difficult to say what predicament the country would be facing.

In borrowing these charts, we're also citing the Maclean's commentary from its economic experts as well as adding our own observations.

Trend #1: You can't keep a good province down


The past two years have been a dispiriting time for Albertans. But it now appears there is some good news on the way. This chart from Trevor Tombe, assistant professor of economics at the University of Calgary (Twitter:@trevortombe), shows job creation will bounce back in Alberta, resulting in a lower unemployment rate.

Writes Tombe in Maclean's: "Collapsing oil prices hit Alberta hard. The past year-and-a-half has seen falling employment, rising unemployment (especially long-term), record-low consumer confidence, and a ballooning provincial deficit. Many wonder when it will end; 2017 could be the year. Various forecasts, from the Bank of Canada, the Conference Board, and more recently ATB Financial, all suggest Alberta’s recession may be over and we’ve started down the long road to recovery. The chart to watch in 2017 is of Alberta’s hopefully healing labour market.”

Trend #2: Even in tough times, there's no taking away from the value resource workers add

You might expect that once the Canadian mining and energy sectors started shedding jobs in late 2014 as world commodity prices tanked, there would be downward pressure on wages. Sadly, we did see a lot of jobs go – but resource wages did not decline. Why? One explanation would be that our highly regulated industries require accuracy and uncompromising commitment to quality. Anyone who has had the privilege of meeting oil and gas workers, or miners, at their job sites quickly comes to understand that there is no room for sub-par performance, not when lives are at stake. We can also infer that resource workers are more likely to enjoy the privileges of union membership, such as protection from short-term wage disturbances.

Earnings are highest in the country

This chart was provided to Maclean's by Todd Hirsch, chief economist, ATB Financial (Twitter: @ABeconomist). He commented: “Canada’s energy sector—the previous powerhouse of the national economy—has suffered tumbling prices over the last two years. Oil companies have been scrambling to get their costs down and efficiencies up, but they’re doing this not by cutting wages, but by cutting headcount. Over the last two years, total employment in resource extraction is down almost 21 per cent (most of that in Alberta). But average weekly earnings—which are the highest in the country—continue to rise. Since 2011 they’re up an astounding 17 per cent."

According to Hirsch: "This tells us two things. The first is that Canada has lost a lot of very high paying jobs. That is taking a toll on the macro-economy, especially in the west. The second thing we learn is that energy companies are opting to cut staff, not wages. If you’re still employed by a Canadian oil company, you still enjoy the highest average earnings in the country.”

Trend #3: Paycheques for Canadian workers generally are stagnant (or worse) 

You've heard of growth, but to Armine Yalnizyan, senior economist with the Canadian Centre for Policy Alternatives, the thing to watch is "slowth".

"In nominal terms, average hourly wages have grown since the recession, but flatlined for hourly employees since 2013," says Yalnizyan. "Adjusted for inflation, they are losing ground. Salaried employees look poised to join them.

That's right - both salaried and hourly workers are seeing the same trend. But wait, there is a bright spot.

"Over the past decade or so, the national average has also been bolstered by strong wage growth from Alberta, a result of the rapid expansion of the energy sector," says Yalnizyan.

"Absent this growth, we see a troubling trend."

Yalnizyan's oberservation reinforces trend #2 that shows the resilience of resource wages.
Rising purchasing power is what makes an economy grow because businesses sell more when people are able to buy more. Yalnizyan concedes that innovation and technology do play an important role in advancing economic potential, but says "it is difficult to achieve economic growth without growing purchasing power, given that most economies are primarily fuelled by domestic consumption."

Mining, forestry and conventional energy jobs matter a lot because they are probably the most solid source of economic growth. Climate policies that cause properly regulated resource industries to unnecessarily shed jobs will not, in the long run, help Canada if voters lose confidence that we can pull off the econonomic-environment balancing act. This is why policies, for example the de facto ban on natural gas in Vancouver, or protection of trade-exposed industries in the national carbon framework, need to carefully consider the economic factors.

Trend #4: The humbling of manufacturing workers that bred Trump is hitting (parts of) Canada


In Canada's traditional manufacturing heartland of southwestern Ontario, industrial job losses have been acute.

According to Jim Stanford, economist and director with the Centre for Future Work at the Australia Institute, the fact that resource jobs have been disappearing in the oil-producing provinces means "the potential for backlash (whether right or left) can’t be discounted, without ambitious policies to cushion the losses of these workers, and create new jobs for them to go to.”

Stanford told Maclean's he looks to employment for explaining the shock victory of Trump.

“The pundits and pollsters will be trying to understand Donald Trump’s shock victory for years to come. But they agree on one point: he was propelled to victory (especially in key battleground seats) by anger and desire for change among a segment of society that’s faced dislocation and underemployment for many years. Thanks to forces of deindustrialization, globalization, deunionization, and the concentration of most new jobs in big coastal cities, the 'middle class dream' has been snatched away from a substantial share of the population who could once reasonably aspire to it."

Canada is coasting on "regional diversity"

Stanford argues that "Canada’s regional diversity, not to mention our stronger public sector and welfare state, help to dilute and salve the resulting hardship." In other words: resource powerhouses BC, Alberta, Saskatchewan and Newfoundland are letting Canada keep its head above water.
The chart above shows the loss of jobs in traditional ‘blue-collar’ industries since 2001 (resources, manufacturing, construction, and utilities), measured as a share of initial employment in the total economy. "Across the U.S. that dislocation totalled more than three workers in 100 over the past 15 years. In the four key Rust Belt states that turned from blue to red and pushed Trump over the top (Michigan, Ohio, Pennsylvania, and Wisconsin), it was more than five in 100," writes Stanford.
"There are hard-hit regions in Canada that have also lost many once-well-paid, goods-producing jobs: New Brunswick has been hardest hit (losing 3.8 industrial jobs from every 100 total jobs that existed in 2001)."

What about in resource-intensive economies in the West and Newfoundland?

Totally different story.

In those regions, industrial jobs were added, not subtracted: "For Canada as a whole there’s been very little net absolute job loss in goods-producing sectors." In the end, it turns out that net manufacturing job losses were offset by new jobs in construction (no doubt some of it building resource infrastructure) and direct resource activities.

Once again, the trend is clear: resources and the jobs created are the single strongest factor keeping Canada strong today.

Trend #5: Signs of further industrial decline in southern Ontario


“Life hasn’t been easy for workers in Canada’s industrial heartland in the years since the Great Recession," argues Rob Gillezeau, assistant professor of economics at the University of Victoria. "Even with a substantial depreciation in the Canadian dollar, the positions that disappeared during the crisis have failed to return.

Gillezeau says in Maclean's that the election of Donald Trump and the Republican sweep of the United States Congress could "drastically increase the rate of Canada’s industrial decline."
A move by the Republicans to introduce national right-to-work legislation will cripple remaining private sector unions and result in a rapid decline in union density.

"This will open the gap in manufacturing union coverage between Canada and the U.S. Rust Belt to unprecedented levels, which will substantially reduce the relative wages and benefits of American workers," says Gillezeau. Depending on the scale of this "compensation shock", plant closures would hit southern Ontario as companies flock south of the border.

According to the economist, "Canadian provincial and federal governments have struggled to cope with the existing pace of industrial decline, making the prospect of an increased rate of deindustrialization particularly concerning.”

Given all the other trends we are seeing in these charts, the importance of resources becomes even more magnified. If we aren't hearing about this often enough, maybe it's because political and academic attention can sometimes seem too narrowly focused on declining industries in the vote-rich central part of the country.

Trend #6: For those awaiting the inevitable resource rebound, here's some good news


If some of these charts require close attention to connect the dots, here's a simpler one. This is the Baltic Dry Index, a measurement that fascinates Finn Poschmann, president and CEO of the Atlantic Provinces Economic Council.

“There’s not much of the world, and not much of Canada, that doesn’t depend on trade in ‘stuff'," he says.

"And Canada sells a lot of heavy stuff. Like coal, ores, nickel and other metals, and grains. Over 2015-16 we’ll have sent about 31 million tonnes of grain to places other than the U.S. And that doesn’t count lentils, mostly to India. Or peas—we will be shipping about a kilo of peas per Indian this year. And if you want to know what is the global state of demand and supply for bulk ‘stuff,’ the Baltic Dry is your index."

To a Baltic Dry Index connoisseur like Poschmann, it's the index's instantaneous measure of demand and supply pressures that he finds so appealing.

"The Dry can be blown off course now and then, owing to the long lag in getting bulk carriers on and off the market, and it is slightly correlated with bunker fuel costs, but its instantaneous slope says a lot about the state of the world. And it has been sending a pretty happy message since summer 2016.”

Along with the optimism of this index, it seems commodities including copper and metallurgical coal are poised for big comebacks in 2017 as the world economy perks up. Fortunately, past investments in building infrastructure are in place to get those commodities to market. The problem we now face is that as the United States loses interest in Canadian oil and gas, the facilities to get those products to overseas markets remains to be built – which means pipelines and LNG plants, , and we are all aware of the challenges there.

If the broader public gets help in understanding why this matters, and why we are quite capable of conducting this shift safely and responsibly, then Canadian resources will continue in future be the thing they clearly are today: a powerful counterweight to the long-term decline of eastern manufacturing.

So what does it all mean?

The takeaway from this crop of charts is clear, crisp and consistent, and every politician and public policy maker in Canada needs to go into 2017 with it committed to heart:

Policies that weaken resource jobs will inevitably weaken Canada. 
From the six trends seen in the charts, here are three main learnings:
  1. Both the resource sector and manufacturing have been battered, but the difference is that resources are coming back while traditional manufacturing is not.
  2. Resource jobs not only pay better than most other jobs, they are more resistant to wage erosion.
  3. The resource/manufacturing contrast is also an east-west contrast pointing to increased reliance in future on the provinces west of Manitoba (plus Newfoundland) as the foundation of the national economy.
Not recognizing these truths is risky. The wrong policies can weaken Canada if they result in lost investment opportunities, fewer job options and fewer fiscal options for governments.

It's also easy to forget that resource jobs create export revenues and royalties to government, and in this way are unique in the economy.

Transition to lower-carbon energy sources is clearly a desirable mission that must be embraced. We also need to understand that this transition will unfold over some span of time, and there is a lot of debate and disagreement right now on the length of this phase. When we hear utopian promises that a predicted boom in alternative energy will allow resource jobs to be "replaced" with jobs that are just as good, it's important to scrutinize the claims closely.

The evidence is overwhelming that Canada has huge potential in resource jobs, potential that other nations envy. It should go without saying that developing our resources means doing so responsibly.
With central Canada's manufacturing in long, slow decline and families suffering as a result, it's clear that prosperity-creating resource jobs still need support to achieve the attention they deserve.

Resource Works is the only educational group in Canada that considers the needs of citizens, the environment, and business in the context of a resource economy. In 2017, we'll be around to continue this work. If you appreciate what we are doing, please let others know about it.

People Worry Too Much and Miss the Big Picture

Humans are full of biases. We often focus on negative facts (especially about the economy) but cannot see the bigger picture which is more encouraging.

With that in mind, please watch the following video -- mainly the first 5-10 minutes, where Hans Rosling illustrates this idea with a few charts on population, poverty, education, and health.

Our ignorance can make us blind, should it's important to be humble and open-minded.

Monday, May 2, 2016

So... Someone Says They Might Want To Buy Your Company?

We have been through the process where an unsolicited buyer shows up on the radar before the Owner begins preparing for the sale of his business. We have learned to consider several key details.

Scenario 1: You decide it's time to sell your company and you begin working through the process to do so.

Scenario 2: An acquirer comes knocking and wants to discuss the potential acquisition of your company.

The pressure on the business owner tends to be a lot lower when the he is well prepared and equipped for negotiations based on market conditions than when a buyer simply approaches the owner "out of the blue."

The two scenarios above each have very different negotiating dynamics and create different stresses for the owner.


When a buyer approaches the owner directly, the buyer is virtually always in the driver's seat.

The buyer knows what they are looking for -- they have already contemplated what they want in terms of the business model, rates of return, risk profiles, etc.

The buyer can talk to as many opportunities as they can find -- with very little consequence.

An owner might find themselves open to the proposal (after all, everything is for sale for the right price) and suddenly wrapped up in early discussions and negotiations about a potential transaction. Inevitably, many owners become very emotionally invested in this process.

But the buyer can simply say "no thanks!" anytime, for whatever reason, and move onto the next opportunity -- having already weighed the owner's best kept confidential secrets.


Outcomes tend to be better when the owner goes to the market rather than when a small part of the market (the unsolicited buyer) goes to the owner.

When the owner has come to the decision to test the market for the right buyer, the process of working through a valuation and building a confidential information memorandum (corporate profile) solidifies the decision to move forward.

The preparation of this data presents the business with "best foot forward", and this encourages better deal outcomes.

The work of getting a company ready to take to market empowers the owner with knowledge of value, market factors, possible due diligence issues, current deal structures, and other elements of an M&A transaction.

This all triggers the owner's resolve to face different types of buyers, opportunities, rejection, and the emotional roller coaster that goes with trying to get the deal closed.


The owner's personal rationalization process has to consider many things, and they are forced to ask themselves a lot of serious questions:

  1. What is the state of my business?
  2. Where am I in my career path?
  3. What do I do after selling the company?
  4. How long will I work for the acquirer?
  5. What about family members who currently work in the business?
  6. How much will I get for my net proceeds?
  7. Will that provide the quality of life I want after selling?
  8. What will my life look like?
  9. What will I look like?
  10. Who will I become?
In the case where owner makes peace with all these questions, then the decisions, time, and energy spent grooming and prepping to complete a strong deal supports that decision. Self-knowledge is critical.


Responding to an unsolicited buyer becomes a rather large secret (and sudden workload) that can only be shared with a few key team members. Confidentiality requires definite planning and consideration as having staff and clients find out about what's going on can trigger troubling consequences.

If an unsolicited deal does not get completed, the owner has to consider how much of his company information will be out in the marketplace. How might that hurt the business? Can the business go back to the regular day-to-day operations?


These potential impacts on the business can be reduced substantially by engaging a professional M&A advisor to lead the process, maximize your readiness, and bring multiple buyers to the negotiations table. When one decides the business is not a good fit the owner does not have to start again from scratch. The momentum towards a closed transaction continues.

"An offer" very rarely becomes "the offer." Many M&A deals never get completed because there are so many issues involved. It pays to have a qualified advisor.

Thursday, March 10, 2016

Using EBITDA the Right Way

There are some things bankers and M&A advisors seem to really love talking about: what they found in due diligence, growth opportunities, working capital, multiples, and EBITDA.

M&A advisors talk a lot about EBITDA (Earnings Before Interest, Tax, Depreciation/Amortization) because transaction values are typically referred to as a "multiple of EBITDA." If your company has $3M in EBITDA and sells for $10.5M, then we say "this company got a 3.5x multiple."

However, a lot of people disparage EBITDA as a metric and some people are confused how much they should care about it. 

It is very important to remember that EBITDA is not the alpha and omega of value. It's just one tool in the valuation toolbox. People use a lot of different metrics to value companies. You cannot represent the earning power of every business model based on EBITDA.

If you are thinking about selling your company, EBITDA is something you're going to think about a lot -- but you need to know what it is and what it isn't. No buyer will evaluate a company purely in terms of EBITDA -- if they do, they're at a big disadvantage.

EBITDA sometimes gets undue emphasis, but it also gets undue criticism. Let's look more carefully at what it means.

Most of the time the anti-EBITDA folks are attacking a strawman. They say things like "EBITDA are fake earnings" and "I’ve never seen a business owner who takes home anything close to EBITDA."

These would be valid complaints if EBITDA were used to describe “real earnings” or if it were claimed to be the amount the owner gets to put in his pocket. In reality, no who wants to be taken seriously is taking those positions.

People love to cite Warren Buffett on matters pertaining to finance and investing. He is a well-known critic of people talking about EBITDA this and EBITDA that. In the 2002 Berkshire Hathaway annual report, he wrote:

"Trumpeting EBITDA (earnings before interest, taxes, depreciation and amortization) is a particularly pernicious practice. Doing so implies that depreciation is not truly an expense, given that it is a “non-cash” charge. That’s nonsense." 

Buffett correctly points out that this is nonsense, but again, I don't know what people are saying "depreciation is not truly an expense." Most finance and accounting types do in fact understand that it's a real expense. It doesn't correspond to the actual outflow of cash; it spreads out the expense for a capital asset over time which is clearly a genuine expense.

If someone actually identifies EBITDA as cash flow and assumes a company doesn't ever have to make capital expenditures, you should seriously reconsider the value of what they are saying. Fortunately most people don't actually think that way. Any business owner will tell you they recognize that plant and equipment assets wear out and need replacement.


So why do advisors talk about EBITDA so much anyway? Why not focus on Net Income (or something else, for that matter)?

To put it in perspective, think about who gets paid when a company earns money: shareholders, lenders, and the taxman.

Take the Net Income right off an income statement and that's basically after-tax earnings left over for shareholders after interest has been paid and the government has taken its slice.

Before we talk about EBITDA, let's consider EBIT (Earnings Before Interest & Taxes). This is just the Net Income with the interest and tax expenses added back in.

That means EBIT ignores the effect of capital structure (i.e. how the company is funded, which drives the "I" in EBIT) and taxes (the "T") to focus on the "core" operations of the business. Importantly, it includes the impact of spending money on capital assets (because the depreciation expense is included).

Unlike Net Income, EBIT reflects money that could go to shareholders and lenders and the government. It's useful because it gives an idea of earnings that could go to owners and how much debt it might sustain. Additionally the tax rate is mostly a given but also affected by events in previous tax years.

EBITDA takes EBIT and adds back depreciation & amortization expenses which reflect spending on property, plant, and equipment. That means EBITDA tries to be an approximation of Cash Flow from Operations on the cash flow statement, where Depreciation and Amortization is also added back because it's a non-cash expense.

Practically, the real Cash Flow from Operations number can be annoying to calculate whereas EBITDA is very simple, hence its popularity.

But remember, it's only an approximation. The actual Cash Flow from Operations includes interest, taxes, and changes in working capital. But relative to Net Income and EBIT, EBITDA will usually (not always) be closer to Cash Flow from Operations. And while it is like EBIT in the sense that it is money that would be distributed to everyone -- the equity investors, the creditors, and the state -- the actual number would be lower because with EBTIDA, companies at the very least still need some capital expenditures to replace old equipment.

So EBITDA is only a quick proxy for Cash Flow from Operations -- which is not the same as profitability. Like EBIT, it looks at the "hard" core of business in terms of its operations, but EBIT is more of a proxy for Free Cash Flow.

Here are a few important things that are not included in EBITDA:
  • Capital expenditures (capex): A lot of companies need to spend cash on property, plant, and equipment assets in order to sustain and grow their businesses. EBITDA doesn't include any of that spending, because it excludes the depreciation/amortization expenses. That means it will always overestimate cash flow to some degree. On the other hand, EBIT could underestimate cash flow -- because even if the Depreciation and Amortization is included, there is no distinguishing between capex for growth vs. capex needed merely to sustain current business levels. It can be more complicated still because companies might have capex to diversify or match their competitors in some area. Capital expenditures are in many ways a function of overall management goals. A company trying to grow aggressively will tend to require greater capex than a company with more conservative growth targets.
  • Working capital requirements: If your working capital needs are decreasing, then that improves valuation, because it frees up more cash. If working capital needs are increasing, this puts downward pressure on the valuation because it ties up more cash. This can be influenced by management decisions like maintaining redundant levels of inventory or credit arrangements with customers and vendors. Fast growing companies have high working capital requirements to accommodate the receivables and inventories. EBITDA doesn't deal with working capital at all, unlike actual cash flow from operations.
With these important exclusions, why do people use EBITDA at all?

EBITDA is useful because sometimes you just want to get a basic look at a company's core business. You don't care how they fund the company (capital structure), tax rates, and individual management decisions that influence working capital levels and capital expenditures.

When a company is sold, it's usually on a debt-free basis where the vendor settles all or most liabilities at closing. This means the capital structure will differ in the hands the new buyer. The tax situation may be different when the ownership changes as well. So there is some justification in utilizing a metric that looks at a company without those factors.

When it comes to depreciation, remember that at best it's an estimate about the life of an asset. A machine might be depreciated to zero yet remain very functional with a substantial amount of fair market value left in it. You don't want to ignore depreciation because it's "non-cash", but you might want to consider it separately from the "core" earnings number.

So despite the complaints about EBITDA, there is logic behind using it as part of one's analysis.
EBITDA is one of the initial filters when a buyer is considering an acquisition. A lot of strategic buyers and private equity firms often won't even look at a company unless it's at least in the 10-20% EBITDA range, and then they start checking under the hood. Getting past those early filters is just part of the analysis though. A company might have very high EBITDA but also underlying issues that still make it a financially weak company.

You would never take an Oil & Gas production company (high capital expenditure requirements), an advertising firm (very low capex requirements), an internet app developer (probably a lot more R&D than investing in big equipment), and compare them all in terms of EBITDA.

In different industries, EBITDA margins are going to mean very different things. A company with lower EBITDA might still produce more Free Cash Flow than a company with higher EBITDA! However, if you are comparing two companies in the same industry, and want a simple approximation to gauge their cash flow from operations, EBITDA can be useful.


After reading this, you probably want an answer to this question: "Should I use EBITDA to measure the value of my company?" 

The question potentially is linked to a false premise, so the answer is "yes" with the proviso that you should never rely on a single metric to value something. Understanding EBITDA's uses and limits helps avoid ideas of value that are confusing and/or confused.

EBITDA in most cases is just the start of an analysis. It allows a quick smell test enabling a snap shot of “GO or NO GO” before further investigation. Buying or running a company with a high EBITDA in and of itself should not be anyone's endgame.