It’s not uncommon at this time of year for prospective sellers of LBM businesses to decide to wait until they have their full year of results to approach the market. This is not strictly necessary in the current competitive M&A environment. Buyers are accustomed to analyzing trailing 12 months’ worth of earnings at any time of the year. Also, recent deals show that buyers are often more focused on earnings for the year ahead anyway.
For companies that do wait to sell, it is natural to contemplate ways to increase earnings and, therefore, the valuation of the company. It is important that sellers focus on making only those changes that serve to enhance, rather than impair, the value of the business.
For example, sellers should continue to try to win significant new customers. A large customer that comes online shortly before a sale will not impact the earnings of the customer, but it may help increase the buyer’s willingness to apply to the company a higher multiple of its EBITDA—its earnings before interest, taxes, depreciation, and amortization. The buyer, after all, will enjoy the benefits of that new customer under their ownership. Also, new customers serve as supporting evidence for the projected future growth.
Companies contemplating a sale sometimes question whether to enter a new product or service area that they know will benefit the business. After all, the expenses of such an undertaking will likely hit the income statement prior to the sale, while the earnings will not. Our recommendation with regard to such items is that, if you would begin the venture in the absence of a sale, you should start the venture. First of all, the sale may not happen. Secondly, if the new service is right for the business, you can take an addback for the expenses related to launching it and deliver the buyer a business that is better poised for growth.
Another step that should be taken prior to a sale is the elimination of obsolete or damaged inventory. Carrying such inventory on the books when entering a sale period can artificially inflate the amount of net working capital that appears to be required to run the business. Even worse, the buyer may disallow such inventory after the working capital peg has already been established. The reduction in net working capital caused by removing this inventory at that point would have to be made up with actual cash.
There are a variety of steps that could be taken to cut costs and increase earnings that, while tempting, would actually impair the value of the company. Examples include cutting marketing and advertising budgets in the months before a sale. When the buyer’s due diligence reveals that such cuts have been made—and it will—the buyer will impose a negative adjustment to earnings to reflect the need to head back to the prior level of spending. The business will also have suffered due to reduced exposure during the period of reduced spending.
expense is another tempting expense item to manipulate. If there are executive
positions that need to be filled, buyers will take a similar negative deduction
if they are left open at the time of the sale. In general, the best rule of
thumb with increasing earnings is to undertake any and all steps that you would
take if no sale were contemplated.