Many buyers, particularly those working at private equity shops and family offices, have experience in larger markets and, therefore, with more financially oriented, data-driven sellers. If this describes your background, it can be helpful to consider the following insights about sellers in the middle markets. You might be surprised by some of these realities
1. If they were pilots, they would fly by sight, not by instrument. They do not make decisions based on data. They do not need the data. They walk the floor. They see how many trucks leave the yards every week. They are in on the big sales call. Their stepson runs the IT department. You of course want the data, but they have not been spending the time or money to collect it.
2. They may not have fully developed back offices. Our clients are successful and their businesses have grown, often beyond their expectations. They are good at what they do and they enjoy being in control. It is common for them to go without hiring a CFO, add staff at certain positions, or turn departments such as HR over to an expert. This means that they may be a little behind in developing the back office. While you might be tempted to chastise them for this, please consider that studies of our clients indicate that this is the number one reason they have come to market.
3. They may not have debt. It is surprising how many businesses with revenues up to $100 million have never had any material amount of debt, especially not bank debt. So, when you speak to them about using leverage in your transaction, or them rolling over into a leveraged business, be prepared for unexpected responses. In addition, recall the mantra that debt imposes discipline. Never having debt, these owners may not adhere to strict discipline when it comes to financial reporting, timely disbursement of invoices to clients, and keeping an eye on the GAAP or IFRS version of “cash flow.”
4. They may view financial statements solely for tax preparation. It may seem a bit surprising, but studies of our clients indicate that the sole use many of them have for financial statements is to allow their accountant to prepare the business’s tax returns. With that in mind, you might see why monthly financials are not available or, if available, not overly reliable.
5. They may not focus on depreciation. Owner-operators are busy growing their businesses, not studying GAAP or IFRS. They may have some significant misconceptions about how depreciation works and why it matters. We do what we can to address this before you speak with our clients but, as they say, we don’t know what we don’t know. Please exercise care when interpreting anything a seller says about depreciation and when communicating these issues with sellers. For example, the difference between accumulated depreciation (on the balance sheet) and depreciation expenses (on the income statement) can trip up some conversations and knock deals off track. Similarly, the concepts of “capitalizing” versus “expensing” costs can get confusing in short order.
6. They may not use budgets or models. Many middle-market business owners started their companies when they were 18 and they never worked in the corporate world. They have worked successfully to this point without being exposed to the concept, or they have seen it just enough to view it as more of a hassle than a benefit. If you do not use budgets, you do not need to borrow money (see above), and you don’t need to build models. Without the historical data from budgets and elsewhere, it is difficult to even make a worthy model. Add to this the obvious issues with coming up with the two key valid assumptions—growth rate and discount rate—and there is simply no way to come up with meaningful models or projections, not to mention a reluctance to attempt to do so.
7. They may define CFO differently. The four terms “CFO,” “Controller,” “CPA,” and “Bookkeeper” are used interchangeably in middle-market companies. Each may have a preconceived meaning to you but there is a 75% chance that these businesses view these titles differently. Set aside your training and experience, try not to judge a book by its cover, and take the time to assess the person in that role (whatever it is called) before making any assumptions.
At Benchmark International, we are well aware of these circumstances. That is why our unique process is built to help you address them, to assist our clients in understanding your standpoint on topics such as these, and to help our clients better speak your language.READ MORE >>