5 Things to Understand When Contemplating a Transaction

July 2019 | Article

By Frank Donati and Matt Labernik

Divesting or acquiring a business may seem like a monumental task. Many successful professionals may only encounter the process once in their career, and the thought of that may make the process seem more daunting than it needs to be. The key to a successful transaction could be summed up in one word—information. There will always be an element of risk involved in transactions, however starting the process with certain questions and an understanding of topics will act as a roadmap that can lead to an informed decision of what is best for your organization.

  • Adjusted EBITDA: Middle market deal prices are often traded based on adjusted EBITDA. Adjusted EBITDA is a term used in transactions to identify unusual and non-recurring events that have impacted EBITDA. For example, the seller may have certain discretionary expenses, relatives on the payroll, non-recurring incentive income, or accounting policy differences during the periods being analyzed. Additionally, the current dealership’s accounting policy elections could impact the analysis of historical EBITDA should the new owner require, or desire, policy changes after purchase. One example could be whether the new owner will elect FIFO vs. LIFO as an inventory method. If the desired inventory method of the buyer is different than what the seller is currently using, adjustments should be made in calculating adjusted EBITDA so that the buyer can make an informed decision.
  • Working Capital: Sellers and buyers often become fixated on adjusted EBITDA during the due diligence phase, but it remains equally important to understand other financial health indicators of the entity, such as working capital. Inventory and floorplan are some of the most significant items on a dealer’s balance sheet. Analyzing inventory levels by product line and completing a turnover analysis allows the buyer to detect slow-moving items. Additionally, reviewing for aged inventory can identify future borrowing base issues or the potential of distressed contribution margin on the aged inventory. Understanding the inventory mix you are acquiring will help you identify issues that could present themselves post-acquisition. Furthermore, identifying adjustments to working capital may help reduce the possibility of money changing hands after the transaction has closed.
  • Location-Based Results: Should you be looking to acquire or sell a dealership with multiple locations, it is important to understand which locations are driving profitability. New locations often add an element of unpredictability that could result in making up for one of your poorly operating locations, or it could keep you up through the night. Additionally, having more than one location in a geographical area can cause increased fixed and overhead costs, as well as market saturation. As either a buyer or seller, it is important to understand the strengths and weaknesses of each of your locations.
  • Profitability by Segment: When evaluating a potential acquisition or sale, an important metric that should be analyzed is profitability by revenue segment. Appropriate segregation of costs provides buyers and sellers insight into the profitability drivers of the entity. These costs are not often easy to identify retroactively, so it’s important an effort be made ahead of the potential sale to provide more detailed insights into what makes the entity profitable. Furthermore, any insight a seller may be able to provide regarding historical profitability trends reduces the risk of a potential issue stalling the deal.
  • Capacity for Growth: Along with financial factors, it is important for a buyer to understand what the target company is capable of in the future and additional costs that may be necessary for planned growth. The target may be operating near or at capacity in the facility they are currently leasing. A buyer’s integration or growth plans could be significantly hindered by unforeseen capital expenditures not identified in the diligence phase.

The Role of an Advisor
Oftentimes, the staff working in the buyer’s dealership will not have the experience or the capacity to analyze and avoid the stumbling blocks related to the topics mentioned above. It is important to understand that the services that transaction advisors or due diligence professional provide can be as simple or extensive as the seller or buyer wishes. Involving your advisors early in the due diligence process allows them to better understand your needs and will help you formulate an appropriate due diligence strategy for your sale or acquisition. Whether it’s a high-level analysis of the entity in preparation for a potential sale, a gross margin analysis of a seller’s revenue streams or detailed historical four-year and projected EBITDA and working capital analysis, your advisor will be able to provide you with the necessary information to make your decision.

For more information, contact your Eide Bailly professional.

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