Some current trends in the restoration space are obvious, others more subtle. We can all admit they’re numerous. I could start with any number of issues: labor, supply chain, gas prices, inflation, etc. However, we’re familiar with these current/potential risks; they greet us at the office every day.
Focusing solely on M&A activity, let’s dive into the current trends and few variables driving deal flow in the restoration space. (Don’t worry, I’ll keep it simple.) These may help provide answers.
Most are fully aware the last two to three years have seen an unprecedented level of activity and industry consolidation. Part of this surge has been driven by Private Equity Groups (PEG’s); they’ve discovered our industry is considered a “safe space”, essentially a secure industry for investment purposes.
There are two additional types of buyers: qualified individuals and the big industry player. Qualified individuals are typically experienced estimators, project managers, or general managers who want to buy their own business, and be in charge of their future. With the current economic pressures, these individuals have already slowed their decision-making and are being extra cautious.
Big industry buyers are still going strong. This trend should continue through 2022 and well into 2023. Time will tell how interest rates and inflation affect future activity.
More Owners Taking ‘Chips Off the Table’
If you’re considering selling, one of the first steps is determining which players fit your business best from a buyer-perspective.
This starts with the size of your company, primarily the adjusted EBITDA (Earnings Before Interest, Taxes, and Amoritization) figure. Smaller businesses will attract qualified individuals, larger businesses will attract the larger industry buyers. After the adjusted EBITDA, it quickly turns to your ideal future after selling. Do you want to sell and completely retire? Or take some chips off the table, by selling say 70% – 90% of your business, and work yet for two or three more years? This approach will mean a second sale of your shares in the years to come; it can be quite profitable.
More restoration owners are seemingly not ready to fully retire, but want to take some chips off the table (locking-in their retirement) and remain working for a few years. There are certainly some advantages to this approach; I suspect this trend will continue.
Some buyers want/need you to stay and continue managing, others would rather have you retire relatively quickly after a sale and transition.
This is a real variable that is both immediate and tangible. Not only is this affecting your lines of credit and vehicles payments, but those with variable mortgages as well. Now, transfer this impact when buying a business and accompanying debt? If your business is worth $10M – $20M or higher, an interest rate hike of 1.5% – 2% translates to an additional $100K a year in debt-service payments for the buyer ($1M over the life of the loan). Higher interest certainly doesn’t mean your business isn’t sellable; it simply means the cost of debt increases. For many, this will impact business value.
Buyer (Perceived) Risk
When buying a business, the process of due diligence is meant to vet the perceived risk in virtually every facet- financial, HR, legal, operations, technology, and more. With labor shortages, increasing cost of labor and materials (and the Xactimate pricing lag), etc., the perceived risk has risen, primarily for PEGs and those not familiar with the industry. Some have abandoned the industry search altogether; others are proceeding cautiously.
Multiples of Adjusted EBITDA
Using multiples can be risky. When somebody indicates they’re after a 3X, 4.5X or 6X multiple, I always ask, “A multiple of what?” Some variation of an extended pause is the common reply.
There’s an array of multiples used with net profit, EBIT, EBITDA and Adjusted EBITDA. Regardless of the size of your restoration company, you should always use a multiple of Adjusted EBITDA. This figure includes:
Applicable EBITDA Adjustments: Interest, Taxes (Income), Depreciation & Amortization
Business Adjustments: Leases, COVID loan forgiveness, grants received, labor adjustments, etc.
Personal Adjustments: Vehicle payments, insurances, gasoline; 401K contributions, meals & entertainment, travel and more.
This collective figure is driving the value of your restoration business. Multiples have increased over the last few years, virtually always ranging from 2.0 – 6.5, though exceptions do exist. With the current market pressures and increased cost of money, these have now stabilized. What’s next? Barring severe interest rate hikes, I believe we’ll stay in this range for the foreseeable future. If interest rates continue to climb, they’ll ultimately hurt your adjusted EBITDA figures and the cost of buyer’s debt, both having a negative effect on business value.
Recession-Resistant vs. Recession-Proof
The bulk of my 20+ year career has been spent in the disaster restoration space. Overall, most restoration companies performed extremely well during the 2008 – 2010 recession and during the recent pandemic. It’s long been said our industry is recession-resistant. It’s also been stated, “As long as there are insurance companies and disasters, we’ll continue to do well’.
Recession-proof may be a bold statement. However, there are few industries more stable during times of economic uncertainty. If the uncertainty worsens, we may all learn if there’s a line separating ‘recession resistant’ from ‘recession proof’.
The (Efficient) Road Ahead
Many owners became more efficient during 2008 – 2010. Again, in 2020, many hired industry consultants, leaned into best practices, creating more systems and procedures to stay lean. Moving forward I see the same. We’ll likely need to be flexible and roll with a few unexpected punches, but I believe the industry will continue to perform at very high levels, delivering solid returns for efficient operators.