Value Judgments
Indianapolis remodeler Geoffrey Horen experienced different growing pains when his company, The Lifestyle Group, purchased Square Deal, a window, door, and flooring company in Crawfordsville, Ind., nine years ago. The opportunity came when his business was in startup mode, and CEO Horen admits he probably broke some rules by adding on before his own company’s identity was fully formed. The goal was not to expand to Crawfordsville, a small town an hour away, but to fast-track the supply chain. “Ideally we were buying it for growth but also as an investment for what we ultimately wanted to do, which was to provide a one-stop shop to our clients and eliminate the middleman,” Horen says.
The jump-start allowed The Lifestyle Group to grow from zero to more than $2 million in four years, but managing the store from a distance was a logistical and cultural puzzle. “We were trying to figure out what we wanted to be, and at the same time trying to run a second company and merge it with what we wanted to build,” he says. “We were trying to grow two things that weren’t a lot alike.” After 9/11, when business flattened in Crawfordsville, Horen brought the branch in-house. A few employees were absorbed into the Indianapolis operation, including a top-notch carpenter who still commutes today. “If you asked me now, would I buy another remodeling company to grow, it’s difficult to know because the value is in the client list,” Horen says. “Most of the time you’re buying people. If the owner goes away, does the opportunity go away?”
It’s a question that Seymour Turner, executive vice president of Chicago–based Airoom has also asked himself. Two years ago his company considered expanding geographically by acquisition. But that idea is on hold as the company refocuses on the Chicago market. “Our core business is complex, requiring 13 trades and a knowledge of local codes and permitting,” he says. “We felt that taking it on the road would be difficult.”
For now, Airoom is adding exterior renovations, home electronics, and energy assessments to its repertoire, with the possibility of spinning off its exteriors segment in other markets. In valuing an acquisition target, Turner tries to calculate the amount of time and money it would take to soak up another company’s knowledge, and the depth of its management layer. “In a classic partnership acquisition, we would look at what they have on the ground in a management team, and how many might stay,” he says. “The reality is, a lot of businesses are managed day-to-day by the owner. Someone looking to retire would not be of interest unless he had a good manager.”
Due Diligence
When the stars do align, there’s still the matter of making an offer. How much is a business worth? The typical valuation for a service business — one times revenue plus inventory — doesn’t apply particularly well to remodeling, since many small companies largely rely on their owner’s participation. There are armies of experts to help remodelers arrive at a number when it’s time to sell. Most want to see accounting records — several years of financial statements, tax returns, a payroll register, a budget for the next year, and an organizational chart. But they also want to know something about the management team’s background and experience. In preparing a starting number for negotiations, Kelly figured out what he might save from coat-tailing on the new company versus starting from scratch, plus what the customer list, building, and vehicles were worth.
“The best indicator is: How likely is it that I will retain the past customers?” Little agrees. “What’s the other company’s average length of customer retention? What’s mine, and how do the numbers compare? How much revenue does this customer generate per year, on average, and what is the lifetime value of that relationship?”
Kelly’s three-month-long due diligence process involved poring through three years of CPA-prepared financial statements and getting client and trade contractor references. And the deal was structured as an asset purchase; he wasn’t taking on payables and receivables or liability for warranties or prior work. In the end, however, it was intangibles such as reputation and creativity that were key.
The soft economy notwithstanding, the Bend operation is roughly meeting projections. “We planned on an additional $800,000 in revenue for this year in Bend,” Kelly reports. “We intend to do $1.5 million next year, and $3 million in three years. Due to the economy, we are seeing some decrease in overall sales, but we are still having a strong year.”
Cheryl Weber is a writer in Lancaster, Pa.
