Recasting Financials to Maximize Business Value

Oilfield Industry Newsletter, September 2014

A Tale of Two Lamborghinis

“On your P&L we noticed a $484,000 one-time expense charged to your American Express account in December. Did you guys buy a couple of trucks on your Amex card to get the air miles?” This was one of a number of drill-down questions Fred and I asked the two business owners as we were preparing a valuation report of their very successful business. Hesitantly, they responded, almost embarrassed – “We bought two Lamborghinis, and yes, we did get the air miles, which we used for a family vacation to Europe.”

Though the pair of Lamborghinis was a bit extraordinary, the motive behind the purchase is a common theme for business owners – to minimize taxes. Business owners enjoy the freedom to manage financial transactions in a manner that suits their personal interests. In many cases these transactions are recorded to minimize the reported net income of the business, which in turn minimizes income taxes to the owner. When preparing a business for sale, a different approach must be taken – to recast the company financials “as if” it was operated to report maximum earnings.

In the oilfield industry, where valuation multiples have become rich again, we invest a lot of time and energy preparing Valuation Reports for business owners before we agree to represent them through the sale of their company. Valuing a business starts with a detailed review of the company’s historical financials and recasting (adjusting) their financials to establish “Adjusted EBITDA”. Adjusted EBITDA significantly improves the earnings of the business by identifying and adding back expenses including excess owner compensation, owner perquisites, equipment and vehicle purchases, family & community expenses, and any non-recurring expenses.

Here are some common EBITDA adjustments we come across in oilfield businesses:

  • Major repairs and improvements expensed as cash that a large corporation would capitalize and depreciate. These include saltwater disposal well work overs, engine replacement, chassis remounts, etc.
  • Family expenses that would be non-recurring to a buyer. These include payroll and benefits for family members not active in the business, vehicles, cell phones, travel, and entertainment.
  • Owner perquisites and hobby expenses. This is a wide category based on personal interests, however in the oilfield some common examples include rare firearms, hunting and fishing trips, boats, planes, luxury vehicles, race cars, motorcycles, and home improvements.
  • Rent expense paid to a sister entity in excess of fair market value.
  • Charitable donations and community support. Most common – the National Rifle Association.

The time and energy we spend recasting company financials is crucial to unlocking maximum transaction value for our clients. Buyers will accept the recast adjustments we prepare for our clients because they are credible and defendable. Since buyers base their purchase price based on a multiple of Adjusted EBITDA, it is important to account for every dollar adjustment because of the magnifying effect it has on the final purchase price of the business. In today’s rich valuation market, 7 times EBITDA in certain circumstances is not unheard of. In this situation, every $1 added back to EBITDA results in a $7 increase in purchase price. Adding back the $40,000 F-150 your son drives to school (paid for, insured, and fueled through the business) increases the value of the business by almost $300,000. Ultimately, it is the responsibility of the seller (and their representatives) to report Adjusted EBITDA to a buyer.

What did we do with the pair of Lamborghinis our client bought? We adjusted them out of the financials and properly supported the adjustment as “owner perquisites”. This resulted in a purchase price increase of nearly $3 million.

Maximizing transaction value begins with the recasting of financials to determine a company’s real earnings “as if” they were owned by a buyer, taking into account the tax minimization and other discretionary expenses that reduce corporate earnings. Understanding buyer appetites and running a competitive auction process adds additional value to the process of a business sale. At Shotgun Capital, we take pride in our ability to maximize the transaction value of our clients every step of the way.

If you’re interested in learning more about our views on the industry or have questions about what your business may be worth, feel free to give us a call anytime at 817.421.5940. Our motto is “no pressure, no B.S.”, and all conversations are held in strict confidence.

Dealing With Unsolicited Offers to Acquire Your Oilfield Business

Oilfield Industry Newsletter, August 2014

We’re often called by oilfield business owners who get blindsided by an unsolicited offer to acquire their business. Most haven’t given serious thought to selling their business, but the number thrown at them made them stop and think.

In this report we provide you with some insight as to why these unsolicited offers are on the rise, how to handle them, and some common mistakes to avoid.

Why? Because rugged is the new sexy.

The oilfield industry has become extremely attractive to private equity firms and large corporations due to the recent growth explosion. Today there are over 40 companies actively chasing deals in the oilfield, many backed by private equity money. These companies are rolling out the red carpet and reaching out to successful business owners like you, and they want nothing more than to lock up an exclusive deal with you to prevent competing offers. Keep in mind that an unsolicited offer that raises your eyebrows may not be the best offer to be had. Unsolicited offers should be a starting point, not an ending point for a deal.

How to handle unsolicited offers to acquire your business.

There’s usually nothing wrong with taking the initial call provided you conduct yourself as if you’re talking with a competitor, and keep it brief. Use the call as a means of fishing for information about their company and their motivations. When the conversation turns to your business, keep it at a high-level and do not disclose any information about your company that is confidential. When in doubt, answer a question with a question, and redirect the conversation back to them. In an initial call you should have learned:

  • Who they are
  • Why they’re interested in your business
  • Whether they have the financial horsepower to complete a deal
  • Who else have they acquired
  • Their ballpark valuation range as a multiple of EBITDA
  • What business characteristics command the high-side of their valuation range
  • Their typical payment structure (cash, note, or stock)

Be forewarned, you’ll most likely be asked for financial information about your business. When you’re asked for financial reports, we recommend taking the old “let’s not put the cart in front of the horse” approach to get them to provide you with their valuation range, usually as a multiple of EBITDA. This will allow you to calculate their valuation range for your business without disclosing financial information. When calculating your EBITDA, it is important to account for all tax-minimization strategies including depreciation, owner perquisites, and personal assets expensed through the business. Race cars, personal vehicles, hunting trips, and other ownership benefits all add back to increase EBITDA. We find these have a significant positive impact on your company’s EBITDA, which in turn exponentially increases your business value.

If you’re unfamiliar with re-casting financials for EBITDA, we can help you with this important exercise – we do it all the time. In a recent valuation report we prepared for a client entertaining an offer for their business which generated $1 million in Net Income, we determined their EBITDA to be $2.5 million after adjustments. The business initially received an unsolicited offer for $10.5 million, which the owner was very excited about — until we brought in a second buyer who offered $15.5 million. What did our client do with the extra $5 million? It’s in a wealth management account growing with the economy.

Don’t make these common mistakes

  • Answering the question “What number would you sell your business for?”
  • Giving away the information farm too early – spending countless hours generating reports “because the buyer needs them to prepare an offer”.
  • Releasing confidential information (financial or otherwise) without securing a bulletproof Non-Disclosure Agreement. (If you need one, we’ll gladly send you one.)
  • Prematurely committing to a single buyer, without adequate review from professionals to determine if the offer is solid, and without backup buyers as leverage.
  • Doing it yourself. Selling your business is not a DIY project. We are here to help, and to increase the value of your deal.
  • Meeting in a bar with a competitor interested in buying your business. After a few drinks, you proceed to tell him how crappy their service is, their management is a joke, their fleet is junk, and their employees ain’t worth a damn. Then, while poking him in the chest, telling him how you could fix his business in 30 days if you were in charge. (This ACTUALLY happened more than once. You have to hear these stories from us!)

Getting an unsolicited offer to buy your oilfield business is exciting. It validates the value of the blood, sweat and sleepless nights you put into building it. Play it right, and you may be able to turn it into your biggest payday yet. With so many credible buyers available to you, we are confident in our ability to maximize the value of your deal.

If you’re interested in learning more about our views on the industry or have questions about what your business may be worth, feel free to give us a call anytime at 817.421.5940. Our motto is “no pressure, no B.S.”, and all conversations are held in strict confidence.

Acquisition Appetites Impact the Value of Oilfield Businesses

Oilfield Industry Newsletter, July 2014

We’ve represented dozens of owners through the complex process of selling their businesses. Many of these clients initially had no interest in selling their business — until we alerted them that buyer appetites were so favorable they should at least entertain some offers. As offers came in, they were astonished at what their business was worth, considered the risk of continued ownership, and sold their business at a significant premium. To sell a business at a premium, an owner needs to understand how buyer appetites can drive up the value of that business.

Understanding How Changing Acquisition Appetites of Buyers Directly Impact the Value of Your Oilfield Business

The largest external influencer on oilfield business value is the constantly changing acquisition appetites of qualified buyers in the industry. When multiple buyers are “on the feed” (actively seeking to acquire oilfield businesses) a window of opportunity opens for a business owner to sell at a premium. These windows only open for brief periods of time, and must be recognized as once in a lifetime opportunities for business owners who envision a life beyond running a business. Chances are, if you don’t act, one of your competitors will.

Let’s take a look at what is currently driving the appetites of buyers of oilfield businesses, how these drivers are impacting the value of your business, and how to stay well informed of buyer activities in the oilfield so that when the window opens for you, you don’t miss out on your once in a lifetime opportunity to cash in at a premium:

  1. Large Corporations Are Buying Their Way Into The Oilfield From Outside The Industry:

    Large corporations that dominate an outside industry with limited prospects for growth in their traditional businesses often look to other industries as a means for growth and diversification. Recently, we’ve seen a number of new players from the waste management and retail propane industries complete strategic entry acquisitions in the oilfield. These publicly traded companies have solid brand names in their traditional businesses, are well funded, and are committed to aggressively expanding their presence in the oilfield through intense acquisition campaigns.

    Typically the initial acquisition targets these companies seek out are well established players in a shale formation, or companies with operations in several shale plays. Once established in a shale play they will continue to acquire smaller “tuck in” companies to quickly grow into a market leading position.

    For a business owner, being one of the first to transact with these new entrants will almost certainly result in a significant premium because getting deals done quickly is a top priority. Oilfield businesses located in the Bakken, Eagle Ford, Marcellus, and Utica shale plays are especially desirable for these companies to acquire and will command a premium value. In this situation, you want to be at the front of the line to capture the largest premium.

  2. The Established Big-Gun Oilfield Companies Are Increasing Their Acquisition Activities:

    In our discussions with the oilfield industry “Big Guns”, they’ve all communicated their increased focus on acquiring businesses to supplement their growth and continue to take out competition in the shale plays. These serial acquirers historically have taken a disciplined approach to acquisition valuations; however, we expect that as they begin to lose deals to the new industry entrants described above, they’ll need to significantly up their valuation offerings to prevent the new entrants from gaining a foothold in the industry. We see this as having real potential to create an environment for deal values to go through the roof in the short term (12 months), especially in the most popular shale plays.

  3. Old Salts Are Buying Back Into The Industry:

    We’re seeing industry veterans who sold their oilfield businesses 5-plus years ago re-entering the industry now that their no-compete agreements have expired. These old salts have significant experience in the industry and are well-funded with the proceeds from the sale of their prior oilfield business. In certain circumstances this adds to the qualified buyer pool for business owners who are considering the sale of their business.

How To Stay Informed of Buyer Appetites In The Oilfield:

A good starting point is the internet, and the merger & acquisitions sections in the oilfield industry publications for press releases and deal announcements. Keep in mind that not all transactions are announced publicly, and information about transaction value or purchase price is usually not disclosed.

Publicly traded corporations will post quarterly analyst presentations in the investor relations section of their website. These presentations will occasionally discuss the company’s acquisition activities and strategy.

The best source of information on buyer appetites and current business valuations is through experienced merger and acquisition firms which actively represent business sales in the oilfield industry. At Shotgun Capital, we welcome every opportunity to speak with business owners in the oilfield and are more than willing to provide them with up to date information on what we’re experiencing in the industry. We interact with the buyers extensively; however our interests lie solely in maximizing deal value for our clients through the sale of their business.

If you’re interested in learning more about our views on the industry or have questions about what your business may be worth, feel free to give us a call anytime at 817.421.5940. Our motto is “no pressure, no B.S.”, and all conversations are held in strict confidence.