Editor’s Note: Adam Coffey is CEO of Coolsys Inc., a Brea-based supplier of HVAC and refrigeration systems for commercial businesses like Walmart, Target and Starbucks. During his career, he’s bought 50 companies and plans to buy 40 more at Coolsys alone. His first book, “The Private Equity Playbook,” was a best seller on Amazon. His newest book that was released earlier this month, “The Exit Strategy Playbook,” is excerpted here. The book has already hit the No. 1 spot in four business categories on Amazon.com. The Business Journal’s Fastest-Growing Private Companies Special Report starts on page 27. Coolsys ranked No. 9, generating 52% growth over a two-year period.
It’s about that time to consider selling your business. You’re a successful entrepreneur, but you’re wondering if there is a light at the end of the tunnel. You’re becoming more conservative. You’re not as young as you once were.
The inflow of capital to private equity—more than $4 trillion, with $1.5 trillion in committed cash looking for companies to buy right now—has financial buyers paying very high prices.
There are sharks out there just waiting to buy a business, and they can detect in a matter of minutes who is a sophisticated seller and who is not.
As part of my current buy and build adventure, I paid $16 million for the first company I purchased as an add-on to my platform. The owner took $12 million off the table to diversify his personal portfolio and rolled over $4 million into CoolSys, the parent company.
Approximately 30 months later, I sold CoolSys for four times the return on investment. That seller who rolled over $4 million got another check for $16 million. Instead of selling his company one time and riding off into the sunset, he sold the company, worked actively, and in total, got $28 million for a company he would have been perfectly content selling for a one-and-done price of $16 million.
Over the last couple of years, I have also seen a hybrid version of owner-operated businesses that marries owner-operated and financial buyers. This relatively new and growing format is called a search fund, which is a small financial buyer that partners with a businessperson, often a recent MBA graduate with some business experience, who goes and searches for a small company to buy and run.
This type of buyer is typically making a lifestyle choice to pivot from a nine-to-five desk job working for someone else to being the business. The investors are banking on the experienced businessperson’s ability to grow the business, and they supply the capital to make the purchase. Search funds typically back the new owner-operator who is looking to buy something in the $5 to $50 million price range and might need $2 to $15 million in equity.
You should begin prepping for sale approximately three years prior to transacting it.
As an entrepreneur, your ultimate goal is to show as little cash profit as possible, recognize as much expense as possible, and defer recognizing revenue as long as possible—all in order to pay less taxes. Not to worry—these are all common practices in founder-owned businesses, and the universe of buyers knows this in advance.
In today’s world, with a lot of financial buyers and strategic buyers out looking for companies to buy, sellers are getting incredibly aggressive at pumping up their reported EBITDA by using a multitude of adjustments—some legitimate and others not. I discount the ones that I think cross a line into the realm of fantasy. In my world, we call that kind of fantasy “mixing Kool-Aid” because the seller wants me to “drink their Kool-Aid.”
No buyer—strategic or financial—wants to own your real estate!
Private equity funds tend to have a 10-year maturity and a typical hold period of five years on the companies they buy. Real estate is considered a very long-term investment and thus is not capital efficient when private equity seeks to generate three times the return on its money over a five-year period. It’s also a different asset class. You may need to spin out your real estate into a separate entity, creating a second empire.
Over the course of my career, I’ve learned that no matter how much money I make, I can’t buy time. It’s the one element that is critical but can’t be purchased.
When I find a potential target to acquire has an employee stock option plan (ESOP), I run the other way. I could spend a ton of money doing diligence and fall in love with the company only to have the majority of employees say no to the acquisition right before the closing. It’s better for me to shift my focus to someone I know is a seller.
Most financial buyers of a business aren’t buying the business—they are investing in you. They are buying your relationships. They fear what happens if you walk out the door.
Prior to my arrival at companies I’ve managed, they had a compounded annual growth rate that ranged from 2% to 8%. In all cases, I was able to bend the growth curve to achieve CAGR of 24% to 27%. That equates to getting organic growth into the high single digits, adding in a few points of margin improvement, and then using buy and build as the central growth strategy to punch it up to the high 20s.
Takeaways:
• You need an heir apparent if you intend to leave after the sale.
• If you want maximum value, you need to have a growth story.
• Understanding your competitors and adding a potential buy and build story increases your valuation.
• Adapting for recessions and pandemics yields tangible increases to valuations.
You shouldn’t target a deal to close during the holidays because people become distracted. If buyers have had a good year, they are less likely to stretch late in Q4, and if bankers have made their money, they’re not quite as hungry facilitating the sale. Lenders tend to be less aggressive when pricing deals because they’ve most likely already achieved their lending quotas. Simply stated, there’s too much downside risk and not enough upside gains in a Q4-launched deal.
By early Q1, everyone is starting the year over; buyers, bankers and lenders come out of the holidays with a renewed hunger to hit the new year’s aggressive growth numbers.
I recently acted as an adviser to a private equity group interested in buying a company. The management team did a great job of presenting.
Later that night at a dinner, the founder of the company had several martinis during a three-hour dinner. He had trouble talking and walking, and he got up from dinner and drove home despite an offer of an Uber ride. That killed the deal. Here was a man who clearly had a problem. What financial buyer wants to take on that risk?
You need to be a leader, not just a manager. Managers are very effective at handling the affairs of an organization. They manage things. Leaders inspire people.
