A few years ago, Frisch Capital was helping an Independent Sponsor review a potential deal prior to submitting his offer. Frisch Capital was helping review the financials of the company and determine if the seller’s asking price was reasonable. At first glance, the company seemed like a pretty good deal. Good revenue, solid products, attractive margins and EBITDA. There were a few issues with customer concentration, but nothing that would prevent the company from being sold near the seller’s asking price. As we began to look at the numbers in more detail, we noticed that the capital expenditures (capex) were high relative to EBITDA. As we began to look at the capex numbers historically, we saw that this was the same pattern dating back every year. For many companies where the capital expenditures are minimal, it is not even a consideration. However, in many companies including those in manufacturing and transportation there can be high capex that has to be taken into consideration when calculating the purchase price. In those cases, the true free cash flow (FCF) is not EBITDA but EBITDA minus capex. So, in the case of this company, what seemed like a reasonable asking price of a 5x multiple of EBITDA turned out to be 10x the true FCF. A deal that started out looking good, suddenly began to look unattractive and way to expensive.
Was the company bad? No! Historically, the company had consistent increases in revenues and EBITDA and steady margins. It could even be a great lower middle market company to purchase, however, not at an 10x multiple purchase price of FCF.
The purchase price of a company can make buying a good company a bad deal, or buying a poor performing company be a good deal. It is all relative and an Independent Sponsor would be wise to remember that. Here at Frisch Capital we have helped Independent Sponsors raise capital for transactions where the purchase price appeared to be too expensive. However, working with capital sources, we were able to show them that the capex was low and the growth projections were “in the bag” with future sales and we successfully closed the deal. On the other extreme, we have helped Independent Sponsors buy companies for as little as $100 to $10,000. While those companies may have had major issues, we were able to refinance the debt and the purchase price was more than reasonable. In both cases above, the purchase price is what determined the perception of a good or bad deal, not the companies themselves. A good purchase price almost always makes all the difference.
For every company, there is an appropriate purchase price. The key word here is appropriate. Anybody can win a deal to purchase a company by outbidding the competition. The sellers will be excited because you offered them such a great price and you will be excited that you won the deal. The problem occurs for an Independent Sponsor when he tries to raise the capital for the transaction. While he may be able to get some debt fairly easily, the problem lies in getting equity sources interested in his deal. The deal will most likely require a lot of equity dollars and the equity capital sources will have difficulty making a decent return (much less sharing the proceeds with the Independent Sponsor). The Independent Sponsor offered too much and the purchase price is too high.
In every transaction making sure the purchase price is appropriate is crucial. No matter how well you know the industry or company, as an Independent Sponsor, it is always important to get a second opinion before submitting your offer to the sellers. There are many professionals, like Frisch Capital, that are more than willing to help you determine if the price you are offering is appropriate. Our advice… be sure to have experienced professionals look at your transaction before you submit your offer.