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.

Monday, February 8, 2016

How Royalties Work and What It Means When Canada Restricts Alberta's Access to Energy Markets

The following remarks, attributed to an Alberta business executive, are interesting for two reasons: 1) They give a helpful overview of how Alberta's oil & gas royalties work for those who don't know, and 2) they explains clearly how Canadians are hurting themselves by essentially embargoing Alberta's energy resources over pedantic (and often contradictory) opposition to pipelines. 

This is worth reading for anyone interested Alberta's oil and gas industry, Canada's energy resources, and the ongoing debate over pipelines:


I am writing this post in an attempt to inform and educate anyone who wants to understand the basics of how the Alberta government receives royalty money from Oil and Gas production in our province.

I will also explain how Alberta has lost BILLIONS of dollars in royalties over the last five or so years (remember this is money that could have paid for new schools, healthcare, social programs, or “insert government funded program of your choice”).

Lastly I will touch base on the impact this discussion has for all of Canada, and what we can ALL do about it.

I will try to keep this high level, but provide enough detail to help understand the basics.

So first: The Oil and Gas industry is divided into 3 main sectors:

  1. UPSTREAM - raw production from wells or open-put mining (this is the only area where Alberta gets paid a royalty).
  2. MIDSTREAM - transporting raw production or refined products -- pipelines, trains, trucks, barge, storage tanks, etc.
  3. DOWNSTREAM - refining of hydrocarbons (oil and gas) into end-use-products -- gasoline, jet fuel, heating oil, lubricants... the list goes on and on.
In regards to royalties, Alberta only receives a royalty on raw production that takes place in the Upstream Sector. This is because the majority of Oil and Gas reserves in Alberta (80%) are located on Crown Land (the government and people of Alberta own the surface/mineral rights). We allow companies to invest money (billions) and establish their operations here to extract that Oil and Gas. We do however set a specific percentage (royalty) that companies must pay to us for every barrel of oil that is produced (I’m really just going to focus on Oilsands because that is where the majority of our Oil and Gas royalty money is generated from. We also receive royalties from natural gas, crude oil and liquids ).

 There are two basic formulas for Oilsands royalties:

  • PRE-PAYOUT - this is when a company has not yet recovered their initial investment. While the company is still working to make their money back on their startup costs, we charge a royalty between 1-9% of their gross revenue. This percentage is dependent on the price of oil (the higher the price of oil, the higher the percentage we take).
  • POST-PAYOUT – at this point the company has recovered their initial investment, so now we (Alberta) take between 25-40% of the company’s net profits. Again – this percentage is dependent on the price of oil. The higher the price of oil, the higher the royalty percentage we take.

This is a very high level explanation of royalties, but I hope it at least helps you to understand the basics about how we make money as a province from our Oil. To give you an idea – in 2014 and early 2015, Alberta was paid approx. 8.3 BILLION in royalty money ... That pays for a lot of government funded services.

Now, I mentioned that I would also explain how Alberta has lost BILLIONS in royalty revenue over the last five or so years. I think many of you will be very shocked to hear the following facts:

Alberta oil production has been growing quite fast over the past 15 years. In the year 2000 we were producing approx. 600K barrels/day. Now in 2015 we are producing around 2.3 Million barrels /day. That’s almost a 400% increase in production!

Unfortunately, while we have increased production, we have NOT built the infrastructure (pipelines) to help transport this increased production to end markets. I’ll try to provide an analogy to make my point: you know how at the end of the year when a clothing store has excess inventory, they throw a massive clear-out sale to get rid of their excess inventory? (They have too much inventory, so they sell it at a discount to get rid of it).

This is essentially what is happening to Alberta Oil! We have more product than we can fit into pipelines, so we sell it at a significant discount to help get rid of it. The price discount applied is anywhere from 10-40%! Remember, we get paid a royalty based on gross revenue (pre-payout), or net profit (post-payout).

Alberta is losing royalty dollars because our oil is landlocked, causing a dramatic discount when we sell it! 

That 8.3 Billion in royalty revenue I quoted should have been substantially greater, but we sold our oil at a discount because we don’t have the infrastructure to ship it to end markets. I hope this makes sense how we have truly taken away money from ourselves by challenging pipelines (the safest method of transporting oil, a product we ALL use every single day). I don’t think that many people understand this.

This discussion of royalties and pipelines has implications for ALL of Canada as well. If what I have mentioned above does not move you, I hope the following facts will:

Canada has the third largest oil reserves in the world, yet we DO NOT provide our entire Country with oil!

Eastern Canada imports millions of barrels of oil every year from countries like SAUDI ARABIA, NIGERIA, IRAQ, VENEZUELA, and ALGERIA.

People claim to fight pipelines in Canada because they are protecting human rights and the environment. Yet we’re completely okay with importing oil from overseas countries that have atrocious human rights violations, and next to no environmental regulations compared to Canada. This is mind boggling and completely illogical. Again – I don’t think that many people understand this.

By protesting pipelines (specifically Energy East), Canadians are saying they would rather import oil from countries with atrocious human rights violations, and little to no environmental regulations compared to Canada (taking away jobs from Canadians and losing additional income tax).

And back to royalties – by protesting pipelines we are losing BILLIONS in royalty dollars, because we can’t ship our products to end markets, so we sell it at a discount (which lowers the royalty we receive).

If you’re a true environmentalist and humanitarian, you would push to buy ONLY CANADIAN OIL! Canada’s Oil industry has some of the tightest environmental regulations in the world! We’re also a world leader in renewable energy (which many people don’t realize).

Please support Canada today and tell our governments (Federally and Provincially) to approve pipelines... OR... your could continue to support foreign oil interests -- the choice is yours!

Thanks for listening.

Please like and share this post to help others understand the basics about this conversation. This topic has implications for all of Canada, regardless whether you work in the industry or not.

Wednesday, February 3, 2016

Keeping a Some Equity When You Sell Your Company

MAXIMA's David Braun recently spoke with Alberta Venture about the scenario where owners keep a share of equity when selling their companies. This can be an attractive transaction outcome for both the seller and the buyer. 

Read the article here: