Revealing the Reasons Four Offers Varied by $16M
During the Cornerstone annual State of M&A Conference held in Green Bay, we organized our own local “shark tank” event. Four private equity (PE) firms were invited to review and submit an offer on a hypothetical company. One by one, they revealed their offers at the event and talked about how they arrived at that value.
This year, we based the deal on a hot tub company, using real numbers from a real business. We were specifically looking to present a company that had experienced a “covid-bump” with a surge in sales since the pandemic.
Things like hot tubs, pools, outdoor furniture, grills, and outdoor lighting all experienced boosts in demand during the pandemic. Since people weren’t traveling or eating out as much, many were investing in their homes and backyards instead.
The question then, was how would buyers value a business that had experienced such a bump? Would they throw out 2020 numbers as an anomaly, or would they factor the increased sales into their offer?
Our sample hot tub company had seen their EBITDA (earnings before interest taxes depreciation and amortization) nearly double from 2019 to 2021, jumping from roughly $3.3 million to $6 million.
But the growth in earnings wasn’t exclusively due to the pandemic. The company had also made a strategic shift from manufacturing hot tubs for private label, to marketing their own brand. They now had their own branded hot tubs for sale, direct to the consumer, on their website. So it wasn’t clear how much of their growth was due to a shift in their business model and how much was from the pandemic.
Offer #1: As the offers were revealed, the lowest one came in at $23 million. This PE firm based their offer on 2019 numbers, the last base year not affected by COVID-19, calculating at a 7.0 multiple ($3.3 million EBITDA x 7). Their offer structure provided significant cash at close with a $5 million earnout.
Offers #2 and #3: Two more offers came in around $30 million. These buyers looked at the trailing twelve months EBITDA of around $6 million and put a 5.0 multiple on the business. The deal structures in these offers were roughly split between 60% equity and 40% debt. Both contained earnouts of around $10 million and proposed the sellers would rollover 20%–40% equity into the new company.
Offer #4: The highest offer came in at $39 million. This firm “bought in” to the hot tub company’s projected sales figures and built their offer on unproved potential. They believed there would be continued momentum in sales, driven in part by FOMO (fear of missing out). As in, I see my neighbor got a hot tub, and now I want one too.
They also liked the direct to consumer model and saw opportunity for ongoing parts and maintenance sales as the hot tubs aged. This PE firm had experience in ecommerce and manufacturing, so it fit their niche, too.
But the $39 million offer came with a couple caveats. Of the deal, $12 million was structured as an earn out. That means the seller only realizes those dollars if future benchmarks are hit. The other caveat is the sellers had to roll over $6 million in equity
Comparatively, that still puts them well above the $22 million offer, but slightly below $30 million. Then again, the $30 million offers also included earnouts and rollovers.
Each of these offers came in from proven, successful private equity firms. One offer came in more than 75% higher, but they all presented different deal structures.
That’s the marketplace right now. There are groups out there that have to put money to work. They’re willing to jump to bigger numbers, especially when they feel they have a secret sauce they can bring to your business – or you have a strength they can build on.
Private equity raised over $900 billion in 2021 alone and spent a record $1 trillion last year for the first time. They’re stacking businesses together, leveraging the synergies, and delivering 18% to 22% rate of returns to their investors.
That’s why the lower middle market is so hot right now. Private equity has money to spend. And as long as their investment model keeps working and outperforming other asset classes, they’ll continue to have dollars and deadlines – and drive.
By Scott Bushkie
With more than 20 years in the Mergers and Acquisitions (M&A) industry, Scott is a recognized leader in the field, providing exit strategies, business valuations, and M&A advisory services to business owners in the lower middle market. He has successfully executed sales to domestic and international buyers, private equity firms, family offices, and strategic buyers. Follow DealCoach on Linkedin