Daron Gifford:
Hello. My name is Daron Gifford. I am a partner leading our commercial due
diligence practice here at Plante Moran. I'm here today with Ted Morgan, a
principal on our commercial due diligence team. We're going to discuss how to
obtain a clear and accurate view of a company's future EBITDA, earnings before
interest, tax depreciation and amortization, and that potential EBITDA during a
sales process. When it comes down to it, this is one of the top challenges for a
buyer to assess and one of the most critical. For this podcast we'll refer to the
company as the seller. Ted, when we mentioned obtaining a clear and accurate
view of a seller's future EBITDA, and that EBITDA potential, what are we actually
looking for?
Ted Morgan:
Thanks Daron. You know, our approach is typically to look at three key areas of
the seller that drive future potential EBITDA. The first is the stability of the
seller's operation. The second is the strength of the, or the attractiveness of the
end markets that are key to the seller's business, and the third is the
reasonableness of the forecasted performance of the seller. So let's give an
example of each.
Regarding the stability of the seller's operations we'll often look at key
operational activities that are core to the seller. Maybe they are launching a, a
new product or service that is key to future growth and we want to dig in to the
details around the seller's operational capabilities to validate the likeliness that
they can get the job done. For assessing the attractiveness of a seller's end
markets we'll conduct market research. Sometimes a seller is in a niche market
for which the buyer has little or no past experience, and for smaller deals even,
we've researched markets that are unknown to most people, let alone the
buyer.
Our market research will cover the key trends, customers, competitors in that
market, and we couple great research skills with access to an immense network
of contact with specific industry experience spanning multiple end markets to
help us execute this type of work. And lastly the forecast, so we've all seen
those deals where the seller is projecting significant growth that looks like a
hockey stick in terms of their predicted revenue. In these situations we want to
get very comfortable the projections are realistic.
It starts with having a good understanding of how the forecast is built, which
can then span into detailed customer due diligence, including interviews and
also researching and reviewing the key cost drivers of the seller. So Daron, on
the subject of customers, let's talk about that a bit further. At the end of the day
business is all about the customer, they drive every dollar, every decision you
make, right?
Daron Gifford:
Absolutely. You've got to know the seller's customers, not just the last three
years of sales trends or their historical product mix. It's much, much, more than
that. Being able to answer the following questions is really important to get a
sense for the, what's the future EBITDA potential at this particular company. For
example, who at the seller owns the relationship with each customer? Are they
throughout the customer organization? Or, is it focused just on a key individual
who may be retiring in a year?
Another question, how are new and existing customers being developed? Also,
what are the top issues that the seller is addressing at each customer? And how
well do the seller's future products or services align with the customer? And
probably the most critical one, is what's really the future growth potential at
each one of the key customers?
Ted Morgan:
All great points Daron and you mentioned products or service alignment with
the customer a moment ago. This is another area a buyer is really going to want
to have nailed down. Understanding things like future demand for the product
or service and what's driving that is important. Is a seller developing new
products or service offerings to maintain or grow customer demand in the
future? As an example, if your manufacture of your back-up camera is sold in
the automotive after market, you better have a future product plan since
demand for the product is likely to diminish over time as these cameras are now
becoming more standard on new vehicles.
Okay, so if you vet the customers, you vet the product or services, what else can
impact future EBITDA potential?
Daron Gifford:
Well there's a number of things but in the interest of time let's cover just one
more. Supply chain due diligence. Many times a seller has relationships with a
few key vendors that are critical to its business. It could be a material supplier, it
could be a temporary agency responsible for providing a meaningful number of
the seller's workforce. It could be a contracted sales representative firm that's
responsible for many of the seller's key customer relationships. Sometimes the
seller has key vendors as well, that are much larger than the seller, and that
could put the seller in a position of low leverage and drive risk into the business.
You really want to do your homework on these third parties. Look at the
contracts that are in place, look at the commercial terms, and really understand
the day to day aspects of how the seller works with these different operations
and these different players. In addition, we also recommend looking at the
seller's balance of qualified suppliers. Look at the key vendors for which there
appears to be only a single source with a limited number of other options. Look
at the operating performance at these key suppliers and really monitor the
supply chain, how it performs and how it's, how it delivers, and really
understand what the risks are around that supply chain.
Ted Morgan:
Well thanks Daron. All important points to try consider when trying to gain
clarity around the seller's future potential EBITDA. Unfortunately, that is all the
time we have today for our podcast but for more information on due diligence
or simply to start a conversation with us, please view our recent private equity
due diligence guide book at diligenceguide.plantemoran.com.
Thanks for listening and enjoy the rest of your day.