Valuing and Acquiring Home Energy Businesses
We are in an industry which has seen downward gallons movement due to conservation and conversion to other energy sources. The use of the internet has changed the way consumers shop for a fuel company. One thing for sure is that our industry is in a crisis. When looking for a definition of crisis I found several sources, but all of them had one similar meaning.
The point of time when it is to be decided whether any affair or course of action must go on, or be modified or terminate; the decisive moment; the turning point.
In any crisis, there is an opportunity. I have heard it said that more millionaires were created during the Great Depression than any time in history. I believe the crisis we are experiencing in our industry is a great opportunity for innovative marketers to prosper and grow. Acquiring other marketers is a great way to accomplish your growth goals. Through this series of articles, we will explore the process of acquisitions and share some insights which will help you accomplish your goals and help you prosper for many years.
Acquisitions are all about a return on your investment. That investment is both a financial one and an investment of your time. Banks are currently very willing to lend money to most marketers at competitive levels which allow marketers to achieve substantial returns above lending interest rates. Even with continued conservation and conversions, home heating oil and propane will continue to be a source of energy for many generations in the future.
Recently I have had the opportunity to meet with several banks who are interested in lending money to companies for acquisitions. The banks were all aggressively seeking to lend money at very reasonable rates. They all stated that the home energy business sector is attractive to them as they see this sector as recession resistant. Banks still have some of the same concerns fuel marketers have. They are concerned about attrition from conversion as well as conservation. While they have concerns about these challenges, they are very supportive of companies who manage their business well and have a good track record.
While financial return is always the major consideration in acquiring a company, making an acquisition is a very rewarding experience in other ways. In addition to the great return on your investment, it is a morale booster for your employees. Employees like to see their company grow. They know that with a growing company they have more job security and an opportunity to advance their careers. Service technicians in particular appreciate less on call time which results from having more technicians to cover the needed hours. Many customers also appreciate the services that a larger company can offer such as more service technicians providing quicker response times, extended hours where they can speak with an employee and not an answering service and many times larger companies offer additional services such as air conditioning repair and in house installation of HVAC equipment.
There is a certain fascination with acquisitions in our industry and there is a misconception that all the acquiring is done by large multi-state marketers. Acquiring a business is a process which is very attainable for most marketers. The process includes finding a good acquisition prospect; calculating a competitive purchase price; structuring the offer for a smooth transaction; presenting the offer in a clear concise manner; navigating the closing process and transitioning the company successfully.
Remember that a crisis is a turning point and that turning point is an opportunity to bring prosperity and a bright future. A good strategic acquisition will help to bring future prosperity to you and your company.
Part 2 Industry Trends
I am fortunate to be able to attend many industry functions and while attending, I am often asked questions on acquisitions and company values.
Through this series on “Valuing and Acquiring Home Energy Businesses” we will address these questions to better understand how the opportunity to acquire fuel companies is an option open to most marketers in our industry. With a little bit of homework and a good relationship with your lending institution, acquisitions can become a part of your growth strategy.
It is important to understand how some trends have stayed the same and how some have changed over the last few years. Below are some trends we have seen in the current acquisition market for Home Energy Companies.
Asset Sales: As has been the trend for many years, almost all transactions include the purchase of assets and not the purchase of the stock of a corporation. This is a disadvantage for a “C” corporation. There has been some good news for C corps in recent years. Recent tax law decisions including the “Martin’s Ice Cream Case” have helped many C corps with regard to tax treatment sale of good will. Consult your tax advisor and if you are considering a sale in the next ten years, you may contemplate electing to become an S corp. now.
Property has become more desirable: Just a few years ago it was very difficult to include real estate as part of a transaction. Now, due to low interest rates and reasonable property values, many purchasers prefer to purchase property rather than lease property. Mortgage payments can be lower than lease payments in many situations. Bulk fuel facilities which are up to date with current satisfactory environmental studies and strategically valuable locations have increased in value. This is especially true for bulk propane storage. In addition, banks sometime prefer to have physical assets as part of a transaction to reduce the ratio between tangible and intangible assets.
Gallons are not used to Value Assets: Gallons may still be used as a payment method but they are not used to value assets or businesses. Companies are generally not valued on a multiple of gross fuel margin and they are usually not valued on a per customer basis. Assets are typically valued on a return on investment calculation. The most common method is a multiple of Earnings Before Interest, Taxes, Depreciation and Amortization (E.B.I.T.D.A.); otherwise known as Cash Flow or Operating Income.
Will Call Customer Values have Increased: As consumer buying habits have changed, purchasers are willing to pay more for will call customers if regular buying behaviors can be established. The key here is to see how many deliveries a will call customers is taking in a season.
Service and Diversified Revenue Streams have Value: As service departments have moved away from lost leaders designed to help sell fuel and more toward profit centers designed to service HVAC equipment, they will add more value to the company. This is also true of other diversified offerings if they can be shown to be profitable and sustainable as a separate business entity. It is rare that purchasers will invest in the potential of a new revenue line. There will need to be a good track record for profits.
Nervous Owners: Many owners are unable or unwilling to keep up with a changing industry. Conversions, conservation and increased competition have eroded profits. Many companies have been forced to downsize operations as gallons have decreased and many customers who were once thankful for the 24/7/365 service are much more likely to complain about the cost of fuel and services. Many owners are just not having as much fun as they once were.
Industry trends and willing lenders have resulted in an unusual combination of having a good supply of companies being offered for sale and a good supply of willing buyers. Our clients have received multiple offers over the last several years and sellers as well as buyers have been pleased with the overall transactions.
Part 3 Finding a Company to Acquire
Companies looking to grow through acquisition will obviously need to find the right company to purchase. The best candidates are companies who “look like you”. If you own most of your propane tanks, have service technicians, sell HVAC equipment, most of your customers on automatic delivery, margins are strong and you deliver in a twenty-five mile radius of your office then the best acquisition candidates will have similar characteristics and deliver in the same area.
Many times, however, you may be faced with opportunities where some of the characteristics are similar and some are different. Deciding what company is the right fit is sometimes a difficult task, but the first step is finding the opportunity.
There are five common methods used to find potential acquisition targets.
1) Develop Relationships with Owners: Picking up the phone, calling an owner and asking if they want to sell their business is not generally received very well. Asking them to have lunch to discuss the industry is a better approach. When I was more involved with purchasing companies, I would develop relationships over years not weeks. The sale of a business is an emotional decision in addition to a financial decision.
Attending industry association meetings and events is another way to begin to develop relationships. You already have a common bond as the challenges you face in everyday business are some of the same challenges they face.
2) Speak with vendors and other industry contacts: If you are looking to grow through acquisition, let people know. Vendors can be particularly helpful. Suppliers and other vendors don’t want to lose business if one of their customers is acquired by a company they do not do business with. They have already built the relationships with the companies and usually know who is getting close to selling.
3) Contact industry brokers: There are several companies in the industry like ours who help owners sell their business. Some owners just want a professional handling the business sale. Brokers in this industry use a targeted approach to a sale. We typically only contact prospective purchasers who we know are good candidates as we do not want to get word on the street about the company sale. If we don’t know you are a viable candidate then we may not contact you.
4) Advertise: If you pick up any industry publication you will see advertisements for companies looking to acquire businesses. The advertisements are typically from the multi-state companies as their target area is larger than a smaller acquirer. A better approach for a smaller company is to send a letter to the owner letting them know that you are looking to acquire businesses. Caution is advised in crafting the letter to make sure you are not offending an owner buy saying we want to buy them out.
5) Search the internet: There are several business sale sites on the web. Two that I have used are Biz Buy Sell http://www.bizbuysell.com/ and Merger Network http://www.mergernetwork.com/ . These sites enable you to set the criteria of the business you would be interested in and you get an email if something comes up.
It is a very rewarding experience to acquire a business and see your company grow. Good luck and good hunting.
Presenting an Offer
Once you have found a company to acquire, you need to structure an offer. A common method for calculating an offer is to look at your return on investment. Most purchasers are looking for a return on investment of between 12% and 30%. That may seem high when money markets are paying less than 1%, but there is a risk reward and purchasing a home energy company comes with some risk.
To make the calculation I would suggest that you look at your income statement or profit and loss statement and make conservative estimates of how the purchase will change your numbers. The first thing to do is calculate the projected gross profit. To do this you will need to multiply the gallons you think you will deliver by the margin you think you will have. To calculate non-fuel revenue, estimate the total non-fuel revenue and subtract the projected cost of any material (don’t include labor). Add the two together and that is your gross profit.
The next step is to project what your operating expenses will be to service the business. Look at each line item expense from your income statement and calculate how much more expense you will have for each line. Now subtract the operating expense from the gross profit and you have the operating income, which is often referred to as “Cash Flow” or “EBITDA” (Earnings Before Interest, Taxes, Depreciation and Amortization). There are other factors that may come into play such as capital needed to invest for items such as propane tanks and vehicles. We recommend working with your accountant to review the numbers before making an offer.
Cash offers are typically well received, but because of the risk involved in an all cash offer, the purchaser usually looks for a higher return on investment which means a lower purchase price. Earn-out offers based on performance are popular as it helps to minimize the risk for the purchaser. Earn-out payments can be based on gallons (retained gallons), gross profit or even EBITDA. There may be some tax incentives for a seller to take a longer payout.
Once you have decided how you want to structure the offer, you need to present it to the seller. Most offers are submitted in a non-binding Letter of Intent (LOI). This is a legal document which should be prepared or reviewed by an attorney. The LOI should spell out exactly what is being purchased and exactly how it will be paid for. It should also address items which are adjustments to the purchase price. Some adjustments are vacation accruals, service contracts, inventory, and prepaid expenses. Other items to cover are non-competition terms, employment contracts, consulting agreements, and other items that have been discussed and agreed to by both parties.
An important item is accounts receivable. Most purchasers want to collect the receivables and either remit them to the seller or buy them as part of the transaction. This gives the purchaser continuity with the customers.
A detailed LOI will help the transaction to go more smoothly as both parties know up front what to expect. The LOI is basically an outline of what the closing documents will be. There will be additional items to negotiate in the closing documents, and that subject is covered in the next article in the series.
Due Diligence and Closing the Transaction
Once you have identified a company to purchase and the seller has accepted your offer, you need to do your due diligence to make sure the information represented by the seller is accurate. There are many areas of due diligence, including Financial (gallons, margins, service revenues, expenses, accounts receivable, etc.), Environmental (Phase 1 & 2 studies etc.), Compliance (DOT records, SPCC Plans, tech licenses etc.), Operational (Vehicles, Computer Systems, Equipment, Sales & Marketing, Payroll etc).
During this process the buyer should get to know the intricacies of the new company. You should ask about employees, customers, vendors, and general operating procedures. This is where you get to learn more about the company than the numbers on the spreadsheet. I also recommend sharing your plans for transitioning the company with the seller. Having the buyer and seller on the same page will create an easier transition.
If you uncover discrepancies in what was represented when the offer was made, or you find that your assumptions when you made your offer have changed, this is the time to discuss any changes with the seller.
Once you have a comfort level with the due diligence, it is time to present the closing documents. In most transactions the buyer’s attorney presents the closing documents to the seller’s broker or attorney. In very large transactions the documents are sometimes presented by the seller.
All transactions will have a Purchase Agreement and there may be separate agreements for Non-Competition, Leases, Property, Throughput, Employment and Consulting. Don’t think that you are done negotiating after you finish the due diligence. There are legal terms in the purchase agreement which will still need to be negotiated, typically between the attorneys. Items such as Indemnifications and Representations & Warranties are two sections which seem to get a lot of attention.
Non-Competition agreements are very common in the home energy industry and the time frame can typically range from three years to ten years. In my experience, a five year non-compete is the most common.
Many times within the closing document phase of the transaction, the purchase price is allocated among the assets. Many buyers prefer to have a higher value on vehicles, propane tanks and equipment so they can depreciate the assets over a shorter period than the customer list value which is typically fifteen years. Sellers typically prefer not to have a large allocation of the purchase price on non-competition or consulting agreements as it will typically be taxed as ordinary income, as opposed to capital gains. Owners of “C” corps are usually an exception. You should always check with your accountant to see how the allocation will affect the net proceeds of the sale.
It is common in the Home Energy Industry to sign the closing documents and transfer ownership the same day. Another way to close on a transaction is to sign the closing documents and have a settlement date a few days or weeks later. In my opinion a settlement date a few weeks later has some advantages. The time lag allows the buyer to complete certain items such as burner service inventory, vehicle inspections, and employee paperwork. From a seller’s standpoint, it is almost impossible to keep the sale quiet when strangers are coming in to do inventories and employees are asked to run all the reports needed for the settlement. The lag time also allows the buyer and seller time to prepare a customer letter if they decide to send one announcing the transaction.
Transitioning Your Acquired Company
You have just closed on your acquisition and it is time to combine the newly acquired assets with your business. This is an exciting time for you and your employees and a critical time to assure the success of the transaction. Remember, it’s not the customers you buy that are important; it’s the customers you keep that will make the acquisition successful.
There are many aspects to a successful transition. Some items you will need to address are the employee announcement, informing customers (or not), hiring employees, transferring account info, payment processing and vehicle registrations to name a few.
When the employees of the acquired company learn about the sale, they will be nervous about their future. I recommend holding a meeting with all the employees you intend to hire. In the meeting it is helpful if the seller thanks them for their service to the company, explains the reason for the sale and shares what he knows about the new owners and why they were the successful buyer.
As a buyer, it is important to let the employees know about your company and why you acquired the business. Assuring them that they will have a job is obviously important. I recommend having new employee paperwork available to be completed the day of closing. It is recommended that as part of the packet you include a non-solicitation agreement as a condition of employment. This will protect your investment as employees will typically be restricted from soliciting customers or employees if they leave your employment. Discuss this with your attorney for more details.
To send a welcome letter to the newly acquired customers, or not, is a common question. Every situation is different so let me share my observations. If the acquired company will operate under the same name, from the same location with the same phone numbers with fuel and service delivered from the same vehicles and no change in billing processes, then it is less important to send a letter. If the acquired company will move the customers into their existing operations then a letter may be recommended. A well written letter explaining the benefits of the combined businesses can be very positive. I recommend using a professional company to help craft the letter; it will be worth the investment.
Transferring account information is a key element to a successful transaction. Many larger transactions transfer account information electronically. This can be a complex process as different systems use different customer code fields which will need to be mapped over properly. Another option is to manually add the information into your systems. It takes a little longer, but you tend to get info in the format you need it.
Payment processing is an item that also needs to be addressed. Many customers are on an automatic credit card payment and the payments will need to be transferred to your account. Make sure your processor is notified quickly to avoid customer deposits going into the wrong account. Tracking payments is important to keep the accounts receivable balances accurate for both the seller and the customer.
It is an exciting time in our industry as we are faced with many challenges. Some companies will be unable or unwilling to face those challenges and other companies will continue to grow and prosper, many through acquiring businesses. Regardless if you are exiting a business or growing your business, the process should be one in which both parties walk away satisfied.