According to a recent survey by BEI Exit Planning Solutions, eighty-one percent of private business owners say they plan to exit their business within the next 10 years, but just 21% have an actual plan.  Furthermore, there is a sub-set of these business owners that have a rolling 5-year exit plan.  In other words, if you had asked them last year about when they plan to exit the business, their answer was “within the next five years”, just as it is today. Yet they still have not taken any decisive actions. Chances are that it will be the same answer next year, so it really is more of an “idea” that a “plan.”  The reality is that if a business owner wants to leave the business on their own terms, it takes a plan.  That means a series of actions and steps that must be taken in a certain order, and in a deliberate way, so that the outcome is optimized.

While a sale to an outside party is only one option of many, it is easy to get a false sense of confidence that your business will be easy to sell.  It is also easy to have a false sense of what your business is worth, and how much you keep after taxes, legal expenses and other fees.  Putting a plan in place to build its value takes more than focusing on growing the topline or your customer base.  It takes a concerted effort to increase the marketability of your business.  That means putting the right processes in place, with the right systems.  It means diversifying your revenue streams and carefully planning capital expenditures.  It means training top talent and putting the right incentive plans in place.  In other words, it is doing a lot of the things you should do anyway, but with a focus on the actions that will make it easier for someone else to take over the reins.  All too often, it is easier to keep doing things the way you always have but have worked just fine.
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An exit often seems far off and it is easy to put aside given the urgency of day-to-day operations.  The reality is if owners don’t set aside some time to plan for their eventual exit, and then begin acting on that plan, they risk falling in the “5-year rolling exit plan” trap and may be forced to stay a lot longer than intended, or exit without an optimal outcome.

The Private Equity (PE) community is an important source of capital for exiting private business owners and in recent years, have been increasingly active in the Produce Industry.  For example, Agribusiness-focused Blue Road Capital recently acquired B&W Quality Growers from Boyne Capital. Additionally, HKW acquired Fresh Direct Produce (and has since made a couple of add-on acquisitions) while Butterfly Equity acquired Bolthouse Farms earlier this year.  While not for everyone or a fit for every situation, this blog article will outline some of the key factors that may impact the value of a produce business when considering taking on a PE partner.

While most PE firms are ostensibly looking for opportunities where their team can add value by implementing operational improvements, the use of debt financing and the acquired company’s ability to pay down that debt can also be important.  Ideally, the target has a leverageable asset base with relatively consistent and predicable cash flow.  This means that it is critical for the acquiring PE firm to understand the stability of a candidate’s customer base.  A high degree of customer concentration, or limited recurring revenue, may be a sign of unreliable future cash flow; impacting the PE firm’s ability use debt effectively.  This increases the cost of capital as the PE firm needs more equity capital to finance the transaction; ultimately lowering the PE firm’s return of equity (ROE) unless they get a corresponding reduction in the purchase price.

In the Produce Industry, reliance on big retailers or food service customers can be a challenge. Maintainable and reliable cash flow can also be impacted by production and supply issues.  A diverse and reliable customer and supply base will help increase the probability of obtaining competitive valuations from PE firms.

Another key factor affecting future cash flow is the capital expenditure (CapEx) requirements of the business.  For example, produce businesses that rely heavily on hard assets like cooling, harvesting, packing and handling equipment need to regularly replace aging assets; further reducing free cash flow to pay down debt.  Some produce businesses, like greenhouse operations, rely heavily on CapEx to grow and expand the business, as production is usually already at maximum capacity for a given square footage.
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Of course, like everything in life, there are always exceptions.  We know of many Private Equity firms that understand the inherent challenges in the Produce Industry. Rather than relying on the extensive use of debt to “financially engineer” a suitably sufficient ROE, they focus on acquiring businesses with talented management teams, so they can work cooperatively to develop growth opportunities, grow EBITDA margins and help the business expand through strategic investments in operations to diversify their revenue and suppliers.

Over the years, many grower/packers have strived to own a larger percentage of the land they farm, as a strategy to increase the value of their business.  By increasing control of product supply and the quality of the produce they pack and ship, they can improve customer relations by proving to be a reliable supplier.  Some produce wholesalers and distributors have backward-integrated into direct production or at least into contractual production for many of the same reasons.

With the general long-term value trend clearly pointing upward for quality farmland, this has been a sound strategy for produce business owners planning inter-generational transitions.  However, for owners that hope to sell their business to an outside party, it can have some unexpected implications, particularly when looking at Private Equity (PE) as a source of liquidity.  While there have been some notable exceptions in the Produce Industry, most PE firms prefer to invest in “asset-light” businesses that have minimal annual capital expenditures. They also often do not want to invest in farmland, as the returns require long holding periods and the risk associated with direct production is more than many are willing to stomach!  As I heard one PE firm put it, “It’s pretty hard to build a disease outbreak, a drought or a hailstorm into our financial models!” PE firms need to have some solid insight in maintainable cash flow to pay down debt used to leverage the transaction.  Generally, they look to make investments where they can add value by making operational improvements, and/or make some add-on acquisitions over a period of 3-7 years.

Obviously, it is the tangible and intangible attributes of the business that drives its value on exit, however, it also is impacted on how you sell the business.  Simply put, the more potential buyers, the more potential competition, the more potential bids and the higher the potential value when sold.  By building a business that attracts strong interest from the “typical” PE buyer, business owners open the door to healthy competition for the business when it is time to exit.  We often see “outliers” when running a competitive sale process, which can create great opportunities for business owners looking to maximize value.  Even if multiple offers come in at similar values, it gives owners choices on who to partner with if they decide to roll equity and provides leverage to negotiate other terms that may be equally important.
Of course, just because you own a lot of land, doesn’t mean a PE exit is out of the question.  As noted above, there are a select sub-set of PE investors that don’t operate on the typical model.  Some even focus exclusively on fully-integrated businesses they intend to hold on to indefinitely.
 
However, a more viable option for many, is to sell the farmland separately, or to retain it and lease it back to a new owner of the operating business. Good farmland is always in demand and can command strong valuations from other local growers.  It can even be sold to private investors or even REITs that are focused on long-term value appreciation.  
Either way, being flexible on including the farmland in a sale, or excluding it and leasing back to a new owner or selling it off separately, can be a smart way to generate stronger interest in your produce business from the PE community.
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Watch out for our next blog post “Private Equity and the Produce Industry - Part 2: Key Business Attributes that Drive Value in a Private Equity Recap”.

I get asked all the time “what multiple do you think my business would sell for?”  For businesses operating in the Produce Industry, my answer is always “that depends!”  Most profitable businesses with less than $10 million in operating profit will trade between 4 to 8 times EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization).  That is a huge variation and there are literally dozens of variables that will impact whether your business trades at the high end or low end of that range.

First, it is helpful to understand what EBITDA is, and why is it used so extensively as a valuation metric.

EBITDA is a proxy for cash flow (before capital expenditures and changes in working capital) and is helpful in comparing one business to another.  It normalizes comparisons of companies’ operating earnings with different levels of debt (interest payments), different tax structures and where different investment decisions have been made (capital expenditures).

Next, potential sellers must understand the period for which the EBITDA multiple applies.  A forward EBITDA multiple is typically based on the current fiscal year before its completion. If a company is growing, the same multiple means a higher enterprise value when compared to an EBITDA based on a previous period.  Buyers however, typically think of EBITDA multiples that are based on the last fiscal year, the average of the last 2-3 years, or more commonly, the trailing twelve month (TTM) period.  It is important that both potential buyer and potential seller are using the same period when talking about EBITDA multiples and their respective valuation expectations.

So, hypothetically, why does a grower packer with $5 million in TTM EBITDA trade for 5x and a value-added processor with the same EBITDA trade for 7x, when they both have the same historical and potential growth?  What makes the processor worth 40% more?

The first important variable may be the EBITDA margin (TTM EBITDA as a percentage of TTM sales).  The grower packer may be generating an EBITDA margin of 5% whereas the processor is generating 10%.  In other words, it takes the grower packer $100 million in sales to generate $5 million in EBITDA, whereas it takes the processor half that amount.  EBITDA margin is a function of both operating efficiency and the company’s ability to differentiate itself in the marketplace.  The processor’s value-added market position may generate higher margins compared to the grower packer that is forced to accept commodity level prices from powerful customers with lots of choices on where they buy.  Ultimately, there are more potential acquirers for a 10% EBITDA margin processor than there are for the 5% EBITDA margin grower packer.  More potential buyers mean more buyer competition, which subsequently can lead to more bids and higher potential multiples.

The grower packer may also have a lot more capital tied up in buildings, equipment and land. It therefore may have much higher capital expenditures to maintain and/or grow its existing operations.  The grower packer may also need more working capital to finance its operations for the same level of profit.  Neither future capital expenditures or changes in working capital are reflected in EBITDA, so it must be reflected in the EBITDA multiple.

Relative to the value of land and water rights, the revenue generated from the farming side of the grower packers’ business may also lower the Return on Investment (ROI) for a new buyer.  The ROI on land is often a combination of the cash it generates and its appreciation over time. Not all investors are interested in investing in long-term land value appreciation.  Grower packers should consider separating land from the operating business (sale-lease-back) to unlock value if a sale is contemplated in the future.  With the operating entity leasing the land at market rates from the land holding company, the EBITDA will drop proportionally but it should attract a higher multiple in a sale.  Furthermore, it gives the seller more options to sell the land to one buyer and the operating business to another which may provide a better overall outcome.  Sale-lease-backs may have tax implications that need to be considered and potential sellers need to get expert advice, specific to their situation on whether the benefits outweigh the costs.
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So next time you ask me about my opinion on what multiple would apply to your business, please forgive me when I start by “that depends!”