Buying and Selling Brands

SEMA News—July 2017

BUSINESS

By Amanda Gubbins

Buying and Selling Brands

Why Merger and Acquisition Activity Continues to Grow in the Automotive Aftermarket

  Merger
The trend toward consolidation in the automotive specialty-equipment market opens a host of options for business owners looking to sell. Before marketing the company, quite a few preparations must be made.
   

With many businesses in the automotive specialty-equipment market experiencing consolidation and some of the biggest names in the automotive sphere at the center of the activity, mergers and acquisitions have become important topics of discussion. As the market began to recover from the Great Recession, consolidation became a growing trend. Since then, private equity (PE) firms have continued to actively invest in aftermarket companies.

According to Paul Louie, managing director for the aftermarket at Cascadia Capital, the industry is on track for a fourth straight year of robust merger and acquisition (M&A) activity.

“We’re definitely in a very nice macro environment that’s very seller-friendly, and it has been since 2014,” he said.

Louie expects the trend to hold steady for the remainder of 2017. Cascadia’s “2017 Automotive Aftermarket Industry Report” outlines a host of contributing factors, including the size and structure of most aftermarket companies, a low national unemployment rate that provides consumers with more disposable income and—specific to the collision and repair segment—growing used-car sales combined with a high number of older cars on the road.

While initially the trend toward consolidation may seem like cause for concern, it can also provide great opportunities for individual owners to extract value from their businesses, Louie said.

Many aftermarket businesses were started by enthusiasts and are what the financial world refers to as lifestyle businesses—businesses that are built to achieve a certain lifestyle for the owner. Perhaps it’s a family- or entrepreneur-owned company.

Those business owners may choose to sell their businesses for a number of reasons. Often they are ready to think about retiring or at least slowing down their work life. Others want to de-risk, especially if their entire net worth is wrapped up in their business, but they may want to maintain a smaller stake in the company.

“It’s really a good time to be an owner because you have all of these options available to you,” Louie said.

Most commonly in the aftermarket, ownership transfers take the form of a majority recapitalization—meaning that the original owner sells a majority stake but retains a smaller portion, such as 30% or 40%. This type of deal is common when a private equity firm purchases the company. Many times, this means that the original CEO can stay on in some capacity, because the private equity buyer still needs management for the company. Then, down the road when the new buyer plans for an exit, the original owner gets to participate in the upside.

The goal for private equity buyers is really quite simple: invest in a company that’s doing well and grow it to make a sizeable return by implementing new structures and best practices. Perhaps they will improve the financial reporting and bring in a dedicated CFO or change the IT functions along with new customer relationship management and enterprise resource planning procedures. By the time five years have passed, the new owner may be able to exit with a return of three to five times the original investment.

“They’re looking for platforms,” explained Louie, “companies that have established a brand and have done very well for the owner. But many times these businesses are more lifestyle in nature—really serving the lifestyle of the owner versus being a buttoned-up corporation that’s built for growth.”

Louie
Paul Louie, managing director for the automotive aftermarket at Cascadia Capital.
webb
Scott Webb, COO and co-owner of Pilot Automotive.
harmola
Garrett Harmola, president and co-owner of Aldan American.
 
       

That said, sellers will walk away from a sale with the most benefit when their business affairs are in order. In fact, when a business owner decides to go the route of working with an investment banker to sell the company, the actual sale is often still two or three years away. The banker begins by evaluating the company—what it’s worth now, what improvements can be made to optimize the value to potential buyers, and so on. There are a number of things that sellers can do to increase their company’s value before beginning to actively market it. Louie focused on four criteria that are generally important to buyers: revenue growth, a robust margin profile, an enthusiast brand, and buttoned-up organizational practices.

Revenue growth is especially important to strategic buyers—in other words, an operating company looking to acquire another operating company.

“For strategic buyers right now, it’s very hard to simply rely on growing organically,” Louie said. “So that’s why you see so much M&A activity, because larger businesses are trying to buy smaller businesses that have growth.”

Next, work toward a margin profile that meets or exceeds the industry standard, as well as brand recognition among automotive enthusiasts. Finally, up-to-date operations processes and financial transparency make a big difference. That might include updating software and equipment, accounting procedures or manufacturing processes for higher efficiency.

“If you have those four things going for you—sales growth, a robust margin profile that’s above industry average, a recognizable enthusiast brand and a buttoned up organization where you have financial transparency—you have a business that’s going to be highly attractive to a multitude of buyers, including family offices, hedge funds, private equity funds and also strategic buyers,” Louie said.

A recent example is Pilot Automotive, a performance accessory manufacturer and one of Cascadia Capital’s clients. Founder Calvin Wang wanted a partner to help grow the company, so he brought Scott Webb on board as COO several months before a portion was sold to a private equity firm. As COO, Webb became involved in every aspect of the day-to-day operations, from writing job descriptions for all 120 employees to negotiating terms of sale with the private equity firm and putting together a strategic plan for the company.

Those steps were necessary to attract the right buyer for Pilot—a private equity firm that was interested in a long-term investment with growth potential rather than in purchasing a company cheaply, doing an overhaul and reselling it quickly.

Having recently been through the acquisition process, Webb had a few recommendations for other SEMA-member companies that might have a similar event on the horizon: Talk to someone else who has successfully done it; make sure you have a good lawyer and an investment banker; and then put in the work to make your business shine to potential buyers—just as you would when selling a car or a house.

“You’ve got little piles and little messes all over the place,” he said. “Clean up the messes, clean up the piles. Make your business look its absolute best and have a plan: What are you going to do next year and the year after that? Put together a three-year plan of how you can demonstrate growth. The PE is going to buy you not for what you’re worth today but for what they see that you can be worth.”

Since the sale, Webb has led a number of initiatives focused on growing the business, including integrating other brands with different types of product lines. Recently, Pilot acquired appearance chemical manufacturer Voodoo Ride and also has an exclusive partnership with truck accessory manufacturer Rolling Big Power.

From Webb’s perspective, a company’s employees are its most valuable assets, so any major changes pre- or post-sale must be carefully considered.

“You really have to manage the organization very delicately, very thoughtfully and very carefully, because you’re affecting people’s lives and their livelihoods. Every decision that you make is going to impact somebody, and you have to understand what that impact is before you do it.”

Pilot retained the employees that were with the company before the acquisition, and the company is actively working to create a supportive and fun work culture. Along with a number of amenities and activities designed to celebrate the company’s employees, Webb said that a big part of it is being mindful of the culture when hiring.

“We have a number of different ways that we positively work to make this a great place to be,” he said. “And we’re very careful about who we let into our team. You’ve got to have fun. We don’t want bad people on our team; we want really fun people who contribute, and we’re very diverse.”

Merger and acquisition activity aside, when a business owner is ready to exit his or her company, it can create an opportunity for an entrepreneur to take on a long-time brand and build it into something new, and larger than before. That is what happened for Garrett Harmola, now president and co-owner of Aldan American, a suspension manufacturer based in Southern California. A longtime automotive enthusiast, Harmola was working in sales and marketing at Hot Rod magazine, where Aldan was one of his clients. The previous owner of Aldan was interested in retiring and selling the business after running the company for more than 30 years. Harmola and his business partner began several months of due diligence before putting a deal together. That included analysis of the company’s finances, product offerings, distributors, and opportunities to grow and scale the company.

For those interested in buying an aftermarket company, Harmola said thorough planning and proper due diligence is key. Being an enthusiast in the space you’re looking into can also be beneficial.

“Evaluating risks and ways in which the deal could fall apart was one of our main goals pre-acquisition. Next was looking at opportunities for growth, scalability of the business and ways to expand profitability. Reducing as much exposure as possible, and by taking on some calculated risks, a deal was struck.”

After Harmola made the leap, the previous owner stayed on for a period of time to help with the transition, and like Pilot, Aldan was able to keep the same employees, some who had been with the company more than 25 years.

“There’s the philosophy of putting the right people in the right seats on the bus and how this concept is helpful in a company, to collectively get where you’re looking to go. Creating and implementing systems and processes that are not reliant upon one single person to accomplish a task are what we’re adding and fine-tuning on a daily basis. I believe for a company that’s looking to scale and grow, by putting good systems and processes in place, and having the right people doing what they’re best at within the company, these elements are important. When these items are not in place within a business, there lies a lot of work, and potential opportunity for a prospective buyer of a business to consider,” he said.

Along with managing the people side of the business, Harmola and his team have been hard at work updating the technology and processes within the company, including IT, accounting, digitizing customer files, launching a new website and standardizing their product data. Aldan American is developing and adding several new product lines to expand their reach, as well as updating their distribution structure to make their products more accessible.

“We’re a 35-year-old company that’s essentially two and a half years old,” Harmola reflected.

Steps to Running a Process

The timeline for marketing and selling a business varies based on many different factors, but Paul Louie, managing director for the aftermarket at Cascadia Capital, said that the entire deal usually takes six or seven months. On a basic level, here are the major steps when working with an investment banker:

1. Build the Standard Process Timeline

This document outlines the necessary steps needed to close the transaction, along with an estimated timeline for each phase of the process. It contains specific dates for key events, including the Indication of Interest (IOI) due date, the Letter of Intent (LOI) due date and the closing and funding dates.

2. Put Together Marketing Material

Typically a task completed in the second month, the investment banker will create a Teaser and a Confidential Information Memorandum (CIM), or the “book.” The Teaser is a one-page document that outlines high-level selling points about the company but does not include the company’s name. The CIM is usually a 40- to 60-page document that describes the company and the management team in more detail, provides investment highlights and growth opportunities, including the market in which the company operates, and historical financial information and projections. Potential buyers are not given the CIM until they sign a confidentiality agreement.

3. Begin Marketing the Business

Once the CIM is approved, the banker begins reaching out to potential buyers and investors. There may be anywhere from 30–100 potential buyers and investors, depending on the client appetite. This step in the process takes about six weeks.

4. Collect IOIs

Potential buyers and investors interested in the company submit IOIs, which outline why they are interested, how much they are willing to pay, usually a range of value, and what their timeline is for closing. It is a high-level, non-binding document.

5. Management Presentations

The investment banker and the client review the IOIs that have been submitted and invite a select group of buyers and investors to meet with the management team. Those management meetings are the client’s first introduction to the potential buyers and investors.

6. Collect LOIs

LOIs are requested from the buyers and investors. They are more formal, lengthy offers and usually include an exact purchase price (though there are a few exceptions). They usually include language and terms that will be found in the stock or asset purchase agreement. This document is more detailed but still non-binding.

7. Negotiations

The offers are negotiated. Usually the investment banker tries to keep more than one buyer or investor in the process so that the client has options before going into exclusivity.

8. Confirmatory Due Diligence

The buyer or investor usually takes between 60–90 days to conduct all of its closing due diligence, acquire the necessary funding, execute the definitive closing documents, and close and fund the transaction.

9. Close the Deal

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