plura Financial Blog

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Posts Tagged ‘EBITDA

Strategic vs. Financial Buyers (the pros & cons)

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If you’re thinking about buying or selling a business, it’s important to know the types of buyers.  Buyers are generally classified into the following two different categories, including the pros and cons of each:

  • Strategic Buyers:  These are companies that believe your business fits well within their existing business, and there is a strategic reason for them to buy that might go beyond monetary gain.
    • Pros
      • Typically offer a higher purchase price than “financial buyers”
      • There may be some competitive advantages from joining forces with another company, including increased purchasing power with suppliers, cross selling to customers, cheaper cost of capital, etc.
      • No immediate plans to flip/sell the company again.
    • Cons
      • Tend to include their company stock as part of the purchase price (instead of giving you all cash at close).
      • They’ll probably fire a bunch of people, including management, because so many positions will be redundant (duplicative).  Part of the reason they pay a higher price than “financial buyers” is because strategic buyers can immediately cut so many costs out of the business; no need for two regional managers at the same company covering the same region.  And every $1 of cost savings the buyer creates is worth $5-$7 due to the EBITDA multiple effect in corporate valuation (companies are generally sold for 5x-7x EBITDA).
  • Financial Buyers:  Investors that are purely interested in monetary gain.  Similar to flipping houses.
    • Pros
      • Most employees, including management, will likely keep their jobs
      • Likely an all cash offer (versus buyer’s stock being part of the purchase price)
    • Cons
      • Increased leverage.  Financial buyers typically use debt to finance up to ~75% of the purchase price, leaving the business saddled with a significant amount of new debt that might strangle the company’s cash flow and limit its financial flexibility.
      • Lower purchase price.  Financial buyers typically pay less for a company than strategic buyers because there are fewer “synergies” to be had that might otherwise justify paying a higher premium.

-Brandon Hinkle / www.pluraFinancial.com

What Banks Look For in a Business Loan

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Brandon Hinkle/www.plurafinancial.com

Banks primarily care about three things when making business loan decisions: cash flow, collateral, and personal guarantor strength.  Generally in that order of importance.  Let’s look at each item in more detail:

What is cash flow?   For banking purposes, cash flow is the pool of company-generated cash that’s available to make debt payments each year; generally this is EBITDA less taxes, dividends, and capital expenditures.  Banks don’t care much about projections; they want historical financial info to ensure there’s a track record of consistent, predictable cash flow.  When a bank is evaluating your loan request, they generally want a 25% cushion (for each $1 of required debt payments you should have at least $1.25 of cash available to make debt payments).  In other words, you need to have more cash flowing in than cash flowing out; ideally, 25% more!

What is collateral?  Collateral is the base of assets available for the bank in case the company is unable to make its debt payments with company-generated cash flow.  Banks typically want the “liquidation value” of the assets/collateral to equal the requested loan amount.  Liquidation value is basically the cash that could be generated by selling the collateral in the next 90 days.  The most common assets that secure a loan are accounts receivable, inventory, commercial real estate, and equipment.  Banks typically give a 20% discount to current accounts receivable & real estate, and a 30-50% discount to inventory and equipment.  For example, if your A/R aging shows $100k of current receivables, balance sheet shows $200k of sellable inventory, no equipment, and real estate that appraises for $500k, you’ll likely be eligible for $580k of debt: ($100k of A/R @ 80%) + ($200k inventory @ 50%) + ($500k real estate @ 80%) = $580k of net eligible collateral.

What is personal guarantor strength?  A personal guarantee (“PG”) basically gives the bank the right to go after your personal assets if the business goes defunct and is unable to service the debt.  A strong personal guarantee, for banking purposes, is one that has liquid assets in excess of the requested loan amount.  Liquid assets generally exclude retirement plans and funds held in trust because they’re not easy for banks to liquidate in a bankruptcy scenario.  The primary goal of a personal guarantee is to align your interest with the bank’s interest of getting the loan repaid.  Afterall, if you don’t stand behind your company, why should the bank?

Other things banks care about: 

  • The company’s net worth because it’s an indication of the cash that would be leftover if the company was liquidated today.
  • Your business & personal credit history, to gain comfort that you’re a responsible person of good character that finds a way to pay your bills on time.  Bankruptcy, for example, is usually a deal killer.
  • Customer concentrations.  If most of your revenue is generated from few customers, you’re more vulnerable than most banks are comfortable with.

In conclusion, banks just need comfort that you can pay the loan back, plus interest, on time.  The more evidence you have of that, the higher your chances of getting a good loan proposal!

For more info about how to find the right loan for your business, check out www.plurafinancial.com

Written by entrabanker

March 20, 2012 at 3:17 am

How to Create a 13 Week Cash Flow Forecast Model

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-Brandon Hinkle/www.plurafinancial.com

If your company is growing quickly, or just tight on cash, you should prepare a “13 Week Cash Flow Forecast” to avoid running out of cash at any given point.  Why 13 weeks?  Because this ensures monthly AND quarterly debt payments are included.  Beyond 13 weeks is less relevant; the short term is much more predicable than the outer months.  The goal is to protect & predict cash flow.

Step 1:  Gather the required info

  • Pull the company’s checking account statements for the last 3-4 months.  Highlight all recurring expenses/payments for salaries, debt, leases & rent, utilities, insurance, bank fees, distributions, capex, etc.
  • Print out your detailed Accounts Payable (“A/P”) aging report.
  • Print out your detailed Accounts Receivable (“A/R”) aging report.

Step 2: Create an excel spreadsheet that shows the weeks across the top, tracking the inflows & outflows of cash.  You should also create a column for Actual next to Budget each week so that you can compare actual activity to forecasted activity.  For example:

  • Create rows for large sources & uses of cash.  For example, payments from large customers, payments to large vendors, salary expense, debt payments, etc.
  • Enter your regularly scheduled payments (the ones you highlighted in the bank statements) in the weekly outflows column.
  • Enter your Vendor payments when they are scheduled to be paid, per your A/P aging.  When you issue a purchase order (“PO”), enter the to-be-purchased amount into the Budget period you expect to make the payment.
  • Enter your Customer cash receipts when they are to be received, per the A/R aging.
  • Your total inflows less your total outflows equals your net cash flow for the week.
  • You weekly net cash flow less your beginning cash balance = ending cash balance.
  • Your ending cash balance plus your line of credit availability = total liquidity.

Step 3: Beware of common mistakes

  • Keep a running tally of cash & liquidity.  For example, next week’s beginning cash balance should be equal to the cash balance at the end of this week.  If you have a line of credit, be sure to include line draws as a source (inflow) of cash and line paydowns as a “use” (outflow) of cash.  If you have a $1 million line of credit with an $800k balance, you have $200k of availability.  If you borrower another $50k this week, then you’ll only have $150k available next week.  The whole point of maintaining a 13 Week Cashflow Forecast is to protect & predict cash and liquidity so this part is important.
  • Keep your line of credit availability updated, particularly if you’re on a borrowing base.
  • Don’t confuse cash bank balance with book balance.  You can’t pay the payroll with funds in float…
  • Be mindful of slow paying customers that don’t pay on time, don’t assume they will start now.
  • Don’t forgot about open POs.  Just because it’s not on the A/P doesn’t mean it won’t need to be paid; some vendors send invoices late, don’t forget about the open POs.
  • Ensure you can easily track results. Make sure the forecast is constructed with the line items that you can easily track.  Elegant projection models are useless unless the line items correspond to easily accessible data.  This helps easily explain/calculate any variance to the budget.
  • Capex happens.  Build in some cushion incase vehicles break down or roofs leak.
  • Be conservative, there’s no upside to making an aggressive cash flow projection.
  • Be proactive.  It’s always best to seek financing when you don’t need it; utilize free resources such as pluraFinancial or local Small Business Development Centers to help match you with the best banks for your business.

 

Written by entrabanker

March 14, 2012 at 3:50 am

How to Value a Business

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Valuing a business is complex.  Experienced practitioners have written novels on the subject, but we don’t have time for that here.  Instead, this represents a high level crash course in business valuation using the “EBITDA multiple” method, which is the most common valuation methodology used by private equity firms, strategic buyers, etc.

Q: How are businesses similar to homes and baseball cards?

A: They are all worth what the highest bidder is willing to pay for them, no more – no less, regardless of what any book says.  As a result, businesses are typically valued based on sale prices of comparable companies (“comps”).  Just as homes in your neighborhood of similar size represent a “comp” for your home, a business comp is roughly defined as another company in your industry, of similar size and similar cash flows.

Valuation Step 1: Calculate EBITDA:  The most basic reason companies have value is because they generate cash; they are an investment that returns cash.  The starting block of every company valuation is calculating its cash flow, or “EBITDA”.   EBITDA is a quick & dirty estimate of the company’s free cash flow; the pool of cash generated by the company’s normal operations, available to make investments and service debt after all other operating expenses have been paid.

Valuation Step 2: Calculate the EBITDA Multiple: Once you calculate the EBITDA, it should be multiplied by a factor, generally between 4x-6x (the “EBITDA Multiple”) for small businesses.  For example if you have a high growth company that spews $100k of cash like clockwork each year, you might be able to sell your business for $600k ($100k EBITDA * 6.0 EBITDA Multiple).  Conversely, if your EBITDA bounced unpredictably between $10k and $150k over the last 10 years, your company is probably worth much less than $600k because a buyer cannot accurately predict how much cash your business will generate going forward.  Here are some key factors that influence your EBITDA Multiple:

Comps:  The starting point for your EBITDA Multiple is likely to be whatever Multiple was used in the last few competitors that were sold in your industry.  This can be difficult to find for smaller businesses, which have much less data available to the public.

EBITDA Predictability: The more predictable your EBITDA, the better “valuation” you will receive.  For example, if your customers are obligated to pay you $X every month (a “subscription model”), than you will receive a valuation boost; there is comfort that the company will continue to generate cash in a predictable way.  If you have “lumpy” sales that rely on winning new, large one-time contracts each year than your valuation will be discounted significantly relative to those that generate more predictable cash flows.

Growth & Market Share: If your EBITDA has been growing each year at significant (e.g. 10%+) rates and are expected to continue to do so, you will receive a higher multiple (e.g. 6x-7x).  If you also have a huge piece of a growing market (e.g. Apple) you may receive an even higher multiple.

As a practical matter, the ability to find debt to finance a portion of the buyout can also impact valuation.  Analogy: if one home is ineligible for mortgage financing, it won’t be as in demand as one that’s debt eligible.

The takeaway here is that each $1 of expense costs you $4-$6 of valuation, so spend wisely.  Focus on EBITDA.  And the more predictable and sustainable your cash flow, the better!

For those looking for a more detailed valuation crash course, I recommend reading “Valuation” by Copeland, Loller, and Murrin at McKinsey & Co.  Disclaimer: nobody knows how to value a startup.

For further information, contact Brandon Hinkle at bhinkle@plurafinancial.com. Brandon is the Co-Founder and CEO of www.plurafinancial.com, a free online matchmaker between banks and small businesses seeking debt financing.

Written by entrabanker

February 9, 2012 at 10:48 pm