By Gary Pittsford®
Consolidation is a growing trend in the industry, which means most hardware retailers are either looking to sell or looking to buy.»
For the retail hardware industry, 2020 has been a very unusual year. The country has been shut down for several months because of the pandemic, but most of the retail hardware store owners have been working overtime. Sales are up at stores across the country. Profits are up and I’ve had lots of store owners call and ask me what they can do with the extra cash that is accumulating in their checking accounts.
Many store owners across the country have a good feeling about their business and are seriously beginning to look for a buyer, because the last three to five years their company has done well and they are finally ready to transition the business to someone else.
At the same time, many store owners that want to grow their organization are aggressively looking for that second, third or fourth store to add to their company. Over the last six to eight years, I have seen a lot of business owners that had one store and now they have four or five stores. There are a lot more multi-store owners across the country than there used to be, as the hardware industry is definitely going through a consolidation phase.
If you are a seller or a buyer, then what are the important points that you should be thinking about as you head down this path of selling a business or buying a business? Let’s look at both scenarios.
Are You a Seller?
If you are seriously thinking about transitioning your company to a new owner and letting them run it for the next 30 years, then there are a few key items that you should be looking at for your company.
First, you want to make sure that your balance sheet and profit and loss statement is accurate for the last three to four years. If you think that the inventory is not accurate or loans from stockholders or loans to stockholders are not accurate, then prepare a short memo and explain what the correct numbers should be. Whatever methods you and your accountant have been using with your financial statements and tax returns for the last 30 years, I don’t want you to make any drastic changes, but be prepared to explain to a potential buyer all adjustments that seem appropriate.
Second, work on your profit and loss statement for 2020 and going into 2021. Try to increase your gross margins 1% or 2% each year for the next two or three years. Also, try to reduce expenses 1% or 2% each year for the next three years. By increasing gross profit income and decreasing expenses by a few dollars each month, you are drastically adding a lot of value to the business.
Third, make sure your employees are well trained and that they have the right job that fits their personality and that their salary and benefits fit their position at the company and their years of service.
If you are selling to your children or someone inside the family, then the techniques used for that type of sale are unique. A combination of gifting and selling can be used with family members.
Selling your business to one or two employees is a little different than selling to your children. The tax rules are different for someone outside the family and the transition options are also different.
If you are selling to another store owner in your industry, then the negotiations are usually more detailed, and the due diligence done by the buyer goes into more detail.
For the seller there may be many sleepless nights, because not only are you selling the machine that generates income for you every year, but you are also limiting your future income. You also have to worry about paying a lot of taxes when you sell your business, what your retirement income is going to look like and how you will protect your net worth so that you can pass it on to your family members. These are tough decisions.
A seller must by surrounded by a good corporate attorney, a knowledgeable business accountant and an excellent financial advisor that knows your industry and knows how to buy or sell businesses. You need these three individuals to help you put together a blueprint to accomplish your goals. Each line of a blueprint represents a question that must be answered, and when done so tactfully, the lines intersect to create the plan, or blueprint, specifically for your situation.
Are You a Buyer?
Since our firm operates in all 50 states, we see sales transactions happening everywhere. The number of transactions has been increasing the last two or three years and I think they will continue to increase for the next five to 10 years. I have noticed in my recent conversations with store owners that their attitudes are better, and many of them have made the decision to seriously work on a succession/exit plan for their company.
There are more buyers today than there were 20 or 30 years ago. There are more multiple store owners than ever before. There are also several large companies that own a hundred stores or more. All these organizations are speeding up their activity to buy the retail stores that have been run by baby boomers for the last 30 years.
If you are a buyer, you are probably looking for a retail hardware store that has sales of $1.5 million to $4 million. When you do your due diligence, you are going to be looking for the company that has the highest gross margin and excellent profitability. You may also be looking for a special situation such as a store that is bigger than normal in rental, or lawn and garden, or a commercial/contractor business.
You have probably groomed one or two key managers that can take over a store, but it is also important for the company you are buying to have excellent employees. It is hard to win a football game with just a quarterback on the field. You need a whole team on the field that is well-trained and experienced at working together.
In your due diligence, I know that you are going to look at tax returns, profit and loss statements, and balance sheets for several years. Or perhaps you will review a valuation report prepared for the seller summarizing all that financial data.
When buyers are meeting with the sellers, I would suggest that you try to listen carefully to what the seller wants. Many times, the seller may be flexible in how the transaction is structured. Paying all cash at closing is expensive for the buyer and it may not be the best option for the seller.
If the buyer is talking to a seller that has a C corporation, be creative and help the seller minimize taxes. Many times, these ideas are not only good for the seller, but also good for the buyer.
Does the seller own the real estate and are they willing to lease it under reasonable terms?
If you are buying a business and you definitely want to buy the real estate, possibly being flexible with the seller will help in the negotiations. Sometimes, if our firm is helping with these transactions, we may suggest that the buyer and seller compromise and perhaps the buyer would sign a 10-year lease but have the option to buy the property after five or six years. This gives the seller a few years of rental income and the buyer knows that they have the property locked in to purchase at a specific date down the road.
As a buyer your due diligence will take some time. You want to look at every item on the balance sheet and every entry on the profit and loss statement.
As a buyer you are wanting to nail down exactly what the assets are that you are buying, and you also want to know what is the usable cash flow of this company, or what accountants call EBITDA. When you look at the tax return, the profit listed on the tax return does not show all of the usable cash flow of the company. Every business owner, whether they are buyers or sellers, has deductible items that the company pays for their benefit. All of these “add-backs” need to be looked at carefully and added in, in order to come up with a more accurate EBITDA.
Once you know what the real cash flow is, then you know how to structure the sale and you also have accurate information that you can give your bank if you are going to be getting a loan for part of the purchase price. The higher the cash flow, or EBITDA, the more the buyer is willing to pay for a company.
We have been telling sellers for many years to increase margins and decrease expenses. This helps create higher usable cash flow and greatly increases the value of their business.
Over the next three to five years there is going to be a lot of sales by independent store owners in the retail hardware industry. If you are a seller, work very hard to make your financial statements look good and increase the value of your business. If you are a buyer, be looking for well-run companies that have great employees, excellent gross margins and a profitable financial history.
I hope the ideas that we have discussed in this article not only help the sellers, but also the buyers as this industry continues to speed up the consolidation process.
Gary Pittsford, CFP®, is president and CEO of Castle Wealth Advisors, LLC and is a contributing writer for The Hardware Connection. Castle specializes in helping families and closely-held business owners with valuations, succession planning, estate and income tax analysis and retirement income security. Castle’s senior partners work with clients throughout the country in making logical decisions that help them fulfill their personal and business financial goals. For more information visit www.Castle3.com, call 1-888-849-9559 or e-mail Gary directly at Gary@Castle3.com.