As many of my readers know, I have spent most of my career leading lower middle market companies, which I define as $50M in revenue and below, through times of growth, transition, and/or distress. Over the years, my team at ACM Capital Partners has assisted approximately 200 companies spanning virtually all industries within the four corners of our country. Obviously, there are inherent differences with each of these companies, but certain commonalities also exist which have eroded enterprise value in many of them. The most common mistake we see again and again is the failure to invest in the back office – principally in the accounting and finance areas.
In addition to assisting struggling companies with financial and operational challenges and providing short-term bridge capital, we also assist private equity firms, family offices and lenders with diligence work. We were recently engaged by an investor to perform buy side diligence on a small manufacturer located in the Southeast.
The anticipated transaction included the majority purchase of the manufacturer’s stock at a 6x multiple of Earnings Before Interest Taxes Depreciation and Amortization or “EBITDA”. As part of the letter of intent signed by the parties, the seller’s financial statements were to be analyzed by a 3rd party for the purposes of determining whether the current financial statements were materially accurate. If it was determined that there were material misstatements, the buyer had the right to reduce the purchase price to adjust for these material misstatements, which is very common in these sorts of transactions.
After several weeks of diligence, our findings uncovered material errors and misstatements that we then communicated to both the seller and the buyer. The result of these findings will likely reduce the purchase price by 50%! To put it another way, the family that is selling this business will do so at a substantial discount, meaning that after paying off the company debt, the seller will have little residual cash left for retirement. The worst part is that all of this was preventable.
In the case of this seller, ironically, we had been hired by them to perform an assessment of their operations and capital structure a few years prior to the anticipated transaction. Our assessment then identified key deficiencies in their accounting, purchasing, payroll and operations. We reported these findings to the client and proposed that they hire an interim financial professional to augment their existing management team and assist them with clearing these deficiencies. Sadly, the client thought that the proposed “cost” was too high and opted to “fix it” themselves.
With the benefit of hindsight and the facts we have uncovered that will likely reduce the purchase price of the manufacturer, we know now that the deficiencies were not corrected. Had the company hired a qualified firm or professional for an interim period to address these deficiencies, it would have yielded an internal rate of return in excess of 330%, or $1,000,000 in lost dollars. This would have been a real boost to the seller’s retirement plan.
Unfortunately, this real-life example is not at all uncommon. This blindside has been a major pain point for many of the companies we’ve worked with and we have addressed it with a new division that provides our client base with a complete back office solution. Unlike the limited services offered by traditional accounting and consulting firms, our service offering includes full time accounting, payroll, IT, human resources, risk management, cash management and financial reporting for the lower middle market.
Not only are our clients profiting from lower costs, but more importantly, they now operate in complete financial transparency thanks to the accurate and timely reporting of a committed, professional team. Other benefits we’re seeing within our client base are receiving new financing more quickly, the waiving of field audits by the lender thanks to their trust in a credible third-party service provider, and more expeditious sale processes at higher multiples than originally contemplated.
The lower middle market is the true engine of our nation’s economy. Unfortunately, many of these companies never get around to properly setting up their back offices and we have seen firsthand how this can erode value. An honest assessment of your current back office infrastructure will often reveal material deficiencies. Your willingness to invest in improving this infrastructure, either through an outsourced firm or internal hires, can restore this value. Our firm is witnessing this first hand.