The Future Is Your Choice
by Tamera Kovacs, Cetane Associates LLC
Despite the energy crisis, we’re still in a seller’s market … but for how long?
In today’s world, when owners are considering their transition strategy, there is a tremendous amount of uncertainty. Business owners are facing difficult challenges in day-to-day operations and many are trying to make the decision as to the right course of action. There is no one magic bullet. It is important to seek knowledge and advice so you can make informed decisions to best achieve your future goals.
Keeping the pulse on the market and asking questions is important. What’s the current status of the acquisition market? What’s the right timing to consider selling or transitioning the business? Are there key areas of focus necessary to build value for future succession planning? These are all good questions to support making an informed decision.
The acquisition market is a cyclical market that ebbs and flows between a buyer’s market and a seller’s market. Over the past 24 years I have seen this shift multiple times in the energy sector, with the last several years being a strong seller’s market for well-run businesses. There is one thing for certain – the acquisition market will eventually shift back to a buyer’s market. The uncertainty is when.
There are multiple factors that support a strong seller’s market or can cause the market to shift to a buyer’s market. Here are a few:
Capital: There’s a lot of capital looking for sound investments where investors can generate a greater yield than with other traditional investment vehicles like stocks and bonds. Investors seek good returns, but they also seek stability. The energy sector provides investors above-market returns in a recession resistant industry. Prior to COVID, investors were more aggressive in the types of markets they chose to enter. The essential energy sector is even more attractive for investors post COVID.
Interest Rates: Low interest rates support a seller’s market. As interest rates increase, the risk of the market shifting to a buyer’s market also increases. Low interest rates help with the cost of capital for acquisitions, capital purchases and the cost of operating a business.
Strong Balance Sheets: Investors seek industries and businesses that have tangible assets and a strong balance sheet, and most well-run energy companies have both.
Granted, there are some things you have little ability to control as a business owner. The one thing you can control is how you run your business, and if you are considering a transition, the timing of exiting the business can be critical.
My favorite question I receive from business owners is, “If I’m considering selling in the next five years, what should I be doing now?” This one question opens so many opportunities to build value and put together an exit strategy. After all, for some of you, this is your life’s work, and for many, your business represents multiple generations of “life’s work”. You have one chance to maximize the value you receive for your business, and in many cases, to preserve the family business legacy.
The one thing to do now — regardless of your timing to transition the business, whether in a sale to a third-party or a family transition — is to know what type of business entity your company is. If it is a C Corporation, it is important to understand the tax implications for when you sell. Almost all fuel distribution or propane companies are sold as an asset transaction, not a stock transaction. Why is this so important? If the company assets are sold as a C Corporation, the amount of money you will realize after taxes will be significantly less than if the assets were sold as an S Corporation or an LLC. It’s the double tax rule; you pay taxes at the corporate level then you pay taxes again when you make the distributions to the owners. Currently, if you were to convert your company from a C to an S Corporation, you would have to wait a five-year “recognition period” before you could fully realize the tax benefit of an S Corporation.
The second thing to do is make sure you have a valuation performed on your business when you make the election. This is important if you choose to sell before the end of the recognition period; if you sell prior to the recognition period, your company is subject to built-in-gains tax. The valuation sets the baseline at the time of the S Corporation election. I challenge you to talk to your accountant and request they run a comparison for you. Pose the following question, “All factors being the same, if I were to sell the assets of my business today, how much after-tax dollars would I realize if I sold as a C Corporation compared to an S Corporation?” I would love to hear the answers.
Earlier I mentioned that the last several years have been a strong seller’s market for well-run businesses or strategic acquisitions. How do buyers classify well-run businesses or strategic acquisitions? What can you do in the meantime to increase your attractiveness to a buyer?
Buyers seek well-run companies with strong cash flow. Companies are valued and acquired based on a multiple of earnings. In addition to looking at the earnings potential in today’s environment, there are some key challenges marketers are facing that can have an impact on a buyer’s interest level in a business. Let’s talk about a few of these challenges.
Legislative Threats: The energy sector faces legislative threats in some states. Some buyers that aren’t currently doing business in those states are opting not to enter, because of these threats. As for businesses currently operating in those states, many buyers are looking at accretive opportunities but may not step into a new territory. It really depends on the quality of the seller’s business and the opportunity.
Staffing: This is a three-pronged challenge. The first is the age of the industry; the second is finding employees; and if you are fortunate to find and hire them, the third challenge becomes keeping the employees, particularly drivers and service technicians. Staff is affecting buyers’ interest levels in businesses. Buyers may not increase their offer, because you are fully staffed, but there is a chance they could reduce their offer if you have a number of staff ready to retire, or if you have key positions open. I recently attended a seminar where the presenter said there are 11 million open jobs and only 7.5 million people to fill them.
Improve Trends: There is no one magic bullet. Look at your trends, gallons, dollars and cents per gallon (cpg). What are the gallons doing? Which gallons are most profitable? What are the gross margin trends by fuel type and customer type? We can all agree that all the operating expenses must come from the gross margin. Are you charging enough to cover your expenses, cover your debt, make new capital purchases, and pay yourself? Gross margin is the easiest place to add value, but improving operational efficiencies has become paramount to improving the bottom line. With the increase in fuel costs, wages, and capital expense items, it is more critical than ever to work on improving operational and delivery efficiencies.
Regardless of your exit strategy or timing, it is good business practice to create an exit strategy. This plan will encourage you to build a strong business while focusing on the future.
Tamera Kovacs is a Director at Cetane Associates LLC and has spent over 20 years in the retail propane/delivered fuels industry, with much of that time performing M&A advisory, business consulting, transition planning, and business valuation services. She can be reached at 860-592-0089 or firstname.lastname@example.org.