Episode 98: How Two Companies Can Combine To Sell

Brian Cohen, Business Strategist for SF&P Advisors returns to To The Point! This time, He’s joined by Kevin Howard of Howard Air and Mike Cross of Scottsdale Air Heating & Cooling to talk about how they combined their companies to sell to a PE firm.

SF&P is a CPA firm that represents sellers and their transactions in private equity. They have completed over 325 transactions in 2021, their 20th year in business. Scottsdale Air is a relatively small but high-performing company of about 30 people, anticipating about 10 million in revenue this year. Howard Air has around 100 employees, and will be close to 20 million in revenue this year since opening in 1977.

Why Was 2021 So Crazy for M&A?

2021 saw quite a few M&A deals done. The rumor of a pending capital gains tax drove a lot of the action; with President Biden saying it would be 40%. While 40% is incredibly unlikely to be approved, most expect the tax increase to be substantial. Smart business owners don’t want to pay more, and who would? If you sell your business for $10,000,000, the first 25% of that is taxed at the normal owner income tax. The other 75% is taxed at the capital gains tax rate, so if that rate is 40%, we’re talking about a huge chunk of cash going straight to Uncle Sam. That’s why a lot of business owners started taking a serious look at capitalizing on the multiples they are being offered. This trend is likely to continue into 2022, but we simply don’t know for how long.

Another thing to factor in is that PE groups borrow money to get these deals done. That means when interest rates go up, purse strings tighten. Multiples can stagnate or even fall down a bit. Brian doesn’t foresee this happening in 2022, and he anticipates next year to be just as busy as 2021. Still, it’s wise to think about your exit strategy regardless of what’s happening in the world. The sooner you have a plan in place, the better. With current conditions, it absolutely makes sense to, at a minimum, play with the idea of what it would look like to sell or partner.

What Are the Types of PE Deals That Get Done?

There are plenty of different structures for PE deals, each dependent on the goals of the owner, but there are two distinct types we can break these up into. These are a 100% buyout, and a partnership. It’s important to understand these options if you’re a business owner, and Brian has overseen plenty of both types of deals.

A Full Exit

A full exit is a 100% buyout in which the buyer (PE firm) partners with the management team of the business, and the seller (owner) exits completely. A lot of times this is an owner in their 60’s, one who has been doing this for 40+ years and isn’t interested in being reinvigorated with a new partner. This type of seller is looking to get paid and move forward with the next chapter of their life.

Partnership

In a partnership, the owner (seller) is going to partner with the PE firm and invest in the fund as well. This is working together to get the business to another level and make money for everyone involved when the equity roll comes around. In a partnership, an owner is running the business from the top-down. Most of the time, business owners are operating bottom-up; with their hands in the soil. When you’re partnered with a PE firm, you’re making decisions from a different level. You have a group of partners who want to help you move this thing forward. The sky’s the limit.

Why Now?

In business, you always know there’s going to be an exit strategy, even if you aren’t (or don’t want to be) thinking about it. At some point, Father Time will remain unbeaten and either pressure you leave or punch your proverbial time card out for you. Mike and Kevin were looking at what was coming down the pike in early 2021. They weren’t really ready to sell, and were focused on building their companies and hitting their goals. Still, with multiples the way they are and the pending capital gains tax increase, they started looking deeper into what an exit strategy in 2021 would look like.

Brain Cohen was the name that kept coming up, and eventually Kevin and Mike sat down with Brian to discuss their options. Brian helped answer their questions and give them confidence about starting the journey of finding a partner.

Multiple People, One Pace

Brian laid out the ground rules for Kevin and Mike, and one of the main things he covered was that the communication between the two would be integral to the success of their deal. The pair have known each other for over 40 years, and operate in adjacent markets. This made them a great candidate for a joint deal.

A lot of people want to pull off what Kevin and Mike did. You might have some buddies who you want to combine with and get that higher EBITDA, but if everyone is moving at different speeds it just won’t work. You need everyone completing steps at the same time or it turns into a frustrating game of babysitting, phone tag, and nothing getting done. It also requires a great deal of effective communication and being able to make important, often difficult decisions together.

This type of offer is appealing to PE firms. It’s more leadership and a bigger number to invest in, which ultimately means size and scale: the two things they want in an investment. Still, it requires double due diligence on the part of the buyer. As it’s multiple deals at once, it’s all the more important for each seller to be on the same page and operate at the same pace to make the process run smoothly.

The Right Fit

We’ve certainly talked about it before, but finding the right fit is essential when considering a PE partnership. Kevin and Mike wanted to talk to as many people as possible to get a full understanding of what was available. They were looking for a chemistry fit, and a partner that aligned with their own goals. They found that in Odyssey Investment Partners, the groups that acquired Service Champions earlier this year. There are a lot of bright minds in this group, including Leland Smith.

It’s not just about taking some of the chips off of the table, either. Kevin and Mike have put a lot of time and effort into their businesses. They’re doing the right things, and focused on treating their employees and customers right. They wanted a partner that would help them maintain the integrity of their businesses, and Service Champions shared those same values. Service Champions also brought to the table labor resources, training resources, marketing resources, and the chance to be part of a bigger family instead of being a platform company for a PE firm looking to make a statement.

Considering An Exit Strategy for 2022?

If Kevin and Mike learned anything from this process, it’s that you can’t sell your business on your own. They, like most small business owners today, were getting 4 or 5 inquiries from PE firms daily. These firms use different language that you may not be familiar with, and knowing how to get the best deal and highest multiples isn’t something most people truly understand how to do. Like a good CPA, a good broker will pay for themselves and then some.

It’s never a bad time to start thinking about your exit strategy. Even if you aren’t ready to sell, there’s no harm in at least equipping yourself with the information of what’s out there today, and what you want for your future. If you’re thinking about your exit strategy, Brian has graciously given us his contact information to share with our listeners. You can reach Brian via email at [email protected], or give him a call at 954-226-3409. Just let him know your name and that you heard him on To The Point, and ask when the best time to connect with him is!