Avoid This Word When Seeking Buyers

Property Management Sellers Don’t Realize How Harmful This Word Is

All industries have their own jargon. Their unique set of terms and expressions. In some cases, they tell a story beautifully. In others, they doom the situation.

The process of selling a property management company carries a unique set of pleasures and pitfalls. Investors are attracted to the recurring revenues. The scalability. The profitability. The low barrier to entry. The recession-proof nature of the industry.

Over the years, I’ve come to loathe a word which many PM sellers love to toss about. They presume it will entice potential acquirers to dive deeper into the story of their business.

Unfortunately, it does the opposite. It usually sends them running to the next deal.

So what’s the dastardly word?

POTENTIAL

In business sales, it’s a death sentence. But most sellers don’t realize it.

The term gets thrown around a lot in commercial real estate circles. Investment opportunities almost always boast of their upside potential. Most commercial investment properties are marketed utilizing a Pro Forma, a sometimes-preposterous assumption of a property’s future profitability. Residential property marketers also like to discuss their subject’s future potential as well.

But in business sales, it’s a different ballgame. A company claiming to have great potential usually gets nowhere on the open market. Why?

Several reasons. Most buyers see it as a red-flag, a back-handed admission of some serious problem. Successful, profitable businesses never talk about their potential. They talk about their successes. Their growth. Their effectiveness.

Troubled or disappointed owners talk about potential. For whatever reason, they haven’t achieved their goals.

Potential is a term that annoys business buyers because it’s often untrue. Or unprovable. Or the chief architect of unreasonable expectations. Sometimes there really isn’t much potential there.

Businesses don’t trade on potential. A buyer may indeed see some unrealized potential down the road through improving efficiencies, better marketing or hiring sales people. But buyers aren’t in the business of rewarding sellers for work they haven’t done.

Business broker Ted Burbank wrote a terrific book nearly a dozen years, “How to Become the Best Business Broker in Town,” that made a lasting impression on me. One excellent point he makes is the distinction between potential and opportunity. The two words sound quite similar but he astutely points out the tremendous differences for business buyers and sellers.

“Owners are unaware of the damage inflicted on their business’s value by emphasizing its potential. It’s a natural and innocent mistake virtually everyone makes.” He compares it to a schoolboy whose teachers and parents constantly talk about Johnny’s potential – and how he’s not achieving it.”

Property management buyers are super smart folks. They make purchases based on verifiable information and historical data. They resist paying sellers for potential profits. After all, why should their hard work down the road go into the seller’s pocket today?

But here’s what they will pay for – opportunity. Burbank writes “It’s perceived differently. Opportunity has already been created by the seller. It’s there. You created the opportunity and are willing to let the newcomer reap the advantages of your hard work. Any reasonable person must be compelled to compensate you for the opportunity you have created. It’s only right.”

Prices based upon opportunity are always superior to those based on potential. The two ideas may sound the same but how it’s communicated and substantiated is very different.

The buyer who sees the most opportunity pays the highest price. That’s where it becomes so important to hire an experienced intermediary who will properly position your company for maximum value. Without a proper guiding hand, it can be trouble. Look at how many businesses sit on the market for months and years without any activity. There are a lot of discouraged sellers with stories to tell.

So stay off the Potential Train. It’s a rough ride to nowhere.

Make Sure You Fully Understand a Letter of Intent

10 Steps to Take Before Signing a Property Management Business LOI

I admit it. I used to hate the Letter of Intent. I know many other business sales professionals who still do.

I spent many years in commercial real estate doing office and retail leasing, institutional investment sales and ground-up development deals. It seemed many investors seemed to enjoy sending LOI’s out by the dozens, hoping to grab the eyeballs of attention-starved sellers and their brokers. It’s common to receive LOI’s from prospective buyers who’ve never seen the property and couldn’t tell you where it is.

These agreements are almost always non-binding, allowing buyers to back out for any reason. It usually obligates the seller to negotiate with the buyer on an exclusive basis going forward, removing the listing from the marketplace. The buyer enters into a due diligence period with the supposed comfort that other prospects won’t make an end run and steal their deal.

Once a business owner signs an LOI, the balance of power shifts dramatically in the buyer’s favor. Once you’re in bed with the buyer, you’ve got to be careful who sleeps where, and when. If not handled properly, with enforceable timeframes and earnest money deposits, buyers are capable of dragging out due diligence for months and manufacturing reasons for better terms and a lower price.

LOI’s work better in business sales than in commercial real estate transactions. They allow business buyers and sellers to warm up to each other without the pressure of a binding contract.

Here are 10 steps every seller should take BEFORE signing an LOI.

1. Making sure your buyer is “real.” An earnest money deposit is often part of the LOI submission. In smaller deals, the EMD will be refundable. On larger deals, portions or all may be non-refundable. It your buyer balks at submitting a deposit, move on. For individual purchasers, get a personal financial statement, credit report, bank statements, more than just a standard proof of funds.
2. Negotiate down the due diligence terms. Most acquirers will ask for a period of 60-90 days. You may be able to negotiate this down to 45 days, maybe 30 with financial buyers. Make sure the LOI has clearly stated timeframes and consequences. The buyer should always know you’re not about to let due diligence drag out. Make it clear there are others at the table, though you’re still honoring the “no-shop” clause.
3. Considering auditing your financials. When numbers don’t make sense, buyers balk. There’s nothing more credible than handing audited statements from a recognized accounting firm to a buyer. Faulty financials are among the leading causes of broken deals.
4. Make sure you understand ALL deal points. Is this a stock or asset sale? Will funds be held by an attorney or escrow? Will you get 100% of the proceeds at closing? Know how the holdbacks, carveouts or seller carry notes will work. What are the contingencies? Do you pay off any longterm debts or does the buyer? One of the biggest mistakes you can make as a business seller is not understanding every element of the proposed transaction.
5. Have detailed discussions with your accountant and financial professionals. I can’t stress this enough. Understand what you will walk away with. How much Uncle Sam gets. How to reduce your tax hit. What all closing costs will be. What are the tax implications of your receivables? Many business owners are dissatisfied upon closing because they didn’t walk away with as much as they expected. You need to know how the numbers will play out.
6. Make sure your supplier and customer contracts have “successor clauses.” Whenever possible, have your contracts include a clause stating the agreement will survive any change of ownership. The presence of this language gives buyers much comfort.
7. Disclose risks and flags to the buyer. All companies have risk factors. The more you disclose at the outset, the easier it will be to build the necessary trust. Heed to adage – “Problems don’t kill deals. Surprises kill deals.”
8. Fully understand and negotiate the non-compete agreement. These can get tricky in the property management space, where multiple offices create different geographic bounderies. How does the LOI limit your future business activities? Are you being adequately compensated? Is there an enforcement mechanism? Can your buyer live without one?
9. Nurture and prepare your references. Acquirers may want to speak to property owners, vendors, employees, attorneys, accountants. Contact a few key “reference-able” folks so they’ll be ready without necessarily indicating the business is for sale. Tell them they’re getting contacted because you’re applying for a business loan.
10. Understand all aspects of the transition. Make sure your role in the post-sale company is clearly defined. Many of these details will not likely be spelled out in writing so a good deal of conversation may be in order before signing the LOI.

Analyzing competing offers is not always easy. Deals often get hung up on issues having little to do with price. Your chances improve tremendously when you truly understand the elements of the LOI and you have a genuine sense of the buyer’s motivations.

This post intended for informational purposes only. It is not intended to constitute legal, tax or investment advice. There is no guarantee that any claims made are accurate or will come to pass. ManageVisors does not warrant the accuracy of the information. Consult a financial, tax or legal professional for specific information related to your own situation.

What Sale Price Did Other PM Businesses Get?

A Look At Past Property Management Deals and Why They Don’t Tell The Whole Story

It’s one of the first questions I typically hear when meeting a property management professional who is giving some thought to selling their business. There is a natural curiosity.

What Do You Think My Business Is Worth?

There are literally dozens of factors that have positive and negative impacts on the value of your company. Valuation specialists utlitize the 3 approaches to value in drawing conclusions – the Asset, Market and Income approaches.

For management companies, the Asset approach is typically discarded. Ours are service-based businesses where the tangible assets rarely match the Market or Income approach values. The discussion here focuses on the Market approach to valuation and what other similar businesses achieved. Sales comps.

Unlike with residential or commercial real estate, sales comps are only employed as very loose frameworks in business valuation. The unique nature of each company makes apples to apples impossible.

We certainly can look at many years of transactions and find key reference points. These reference points are expressed as multiples. It can be a multiple of earnings. A multiple of gross revenue. A multiple of gross profit margin. A multiple of EBIT or EBITDA. A multiple of monthly management contracts.

An analysis of the last decade of property management transactions tells us a few things we likely could’ve assumed already:

1. High revenue companies will achieve a greater multiple than smaller firms.
2. Businesses showing a rapid or recent rise in revenues or earnings achieve higher multiples than companies showing flat or declining numbers.
3. Management companies who’ve taken the time to highly automate their processes achieve higher multiples.
4. Companies where the owner has little or no role in daily operations get a higher multiple.
5. Businesses with more than 5 years of operations get higher multiples.
6. Property management buyers rarely reach a purchase price equal to one year’s annual revenues. A $1 Million revenue company is not likely to get a $1Million purchase price.
7. Companies with highly developed marketing processes and automations will get higher multiples than ones with lots of manual process.
8. Businesses with strong balance sheets and little or no longterm debt get a higher multiple.

So what are the price ranges?

We did a review of almost 100 property management companies sold throughout the U.S. in the last decade. These comps include residential, commercial, HOA and vacation rental property management businesses. Real estate offices and brokerages were discarded. There were, by far, more comps reported in Florida than any other state. That’s partly due to the state’s very active vacation rental marketplace. It also points to the fact that Florida brokers, M&A professionals and sales associations are better about reporting transactions than other parts of the country.

Keep in mind, this analysis is limited to property management companies doing between $500,000 and $5 Million in revenues. We only included businesses booking at least half a million dollars in third-party management revenues.

Some median numbers we found in this analysis, for the 90-plus PM companies purchased:

1. Median Gross Revenues – $797,080
2. Median Seller’s Discretionary Earnings – $153,056
3. Median Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA) – $66,697
4. Median SDE Margins – 15.4% (SDE as a percentage of gross revenues)
5. Median Purchase Price – $365,000

So here are some of the multiples which create the reference points in the sales comps.

1. Median Purchase Price as a percentage of SDE – 2.5 times SDE. The 25^th percentile businesses achieved 1.9 times SDE while the 75^th percentile sales hit 3.1 times SDE.
2. Median Purchase Price as a percentage of EBITDA – 5.0 times EBITDA. The 25^th percentile businesses achieved 3.0 times EBITDA while the 75^th percentile companies hit 11.6 times EBITDA.
3. Median Purchase Price as a percentage of annual Gross Revenues – 41%. The 25^th percentile businesses achieved 32% of revenues while the 75^th percentile companies got 49% of revenues. The 90^th percentile PM companies reached 73% of revenues.

Again, these numbers don’t tell the whole valuation story. They certainly shouldn’t be used as arbitrary conclusions of your company’s value.

First off, there are marketplace considerations which can drive values up or down. These figures are national. There will be state and regional variations in value. Companies with office locations in rural and small towns will see fewer buyers, and lower prices, than those in major metros.

Timing also plays a role. There was a record number of property management companies sold in 2018. As we work through our post-COVID futures in 2020, the multiples are likely to get  pushed down. The typical timeframe to sell a PM business is between 6-12 months.

With these comps in mind, our business valuation experts will then examine the 8 key drivers of your company value to refine the pricing. Included in those calculations is your personal readiness to sell the business.

So these sales comps are good tools as a starting point in the valuation process. But you’d make a big mistake in presuming these are how much your business is worth.

That’s why we encourage you to sign up for a ManageVisors business valuation. It’s free and takes a much deeper dive into the factors that determine the pricing of your company. We also offer fee-based certified valuations, recommended when making decisions related to stock purchases, estate planning and legal matters.

This post intended for informational purposes only. It is not intended to constitute legal, tax or investment advice. There is no guarantee that any claims made are accurate or will come to pass. ManageVisors does not warrant the accuracy of the information. Consult a financial, tax or legal professional for specific information related to your own situation.