Acquisitions Anonymous - #1 for business buying, selling and operating - A micro-sized D2C beauty Co, West Coast Solar Installer - Acquisitions Anonymous e3

Episode Date: September 23, 2020

This week we talk about two SMB M&A deals:* A micro-sized D2C beauty company* A large, fast growing west coast residential solar installer-----* Do you love Acquanon and want to see our smiling faces? Subscribe to our Youtube channel.* Do you enjoy our content? Rate our show!* Follow us on twitter @acquanon Learnings about small business acquisitions and operations.-----Past guests on Acquanon include Nick Huber, Brent Beshore, Aaron Rubin, Mike Botkin, Ari Ozick, Mitchell Baldridge, Xavier Helgelsen, Mike Loftus, Steve Divitkos, Dzmitry Miranovich, Morgan Tate and more.-----Additional episodes you might enjoy:#62 Two Landscaping Businesses for Sale - Mike Loftus CEO of Connor's Landscaping#66 Analyzing Software Businesses for Sale with Steve Divitkos, experienced industry CEO#42 $900k Moving and Storage Company / $500k Rural Mini-Storage#61 Two Manufacturing Businesses for Sale - Brent Beshore - Founder and CEO at Permanent Equity#24 $5mm pool services and lifeguard staffing co / $2mm septic services business -  featuring baller @WilsonCompanies as a special guest!#45 $800k/yr cleaning business in Midland, TX / a $565k/yr window cleaning business in San Antonio, TX #48 Two Landscaping Businesses for Sale - Mike Botkin of Benchmark GroupSubscribe to weekly our Newsletter and get curated deals in your inboxAdvertise with us by clicking here Do you love Acquanon and want to see our smiling faces? Subscribe to our Youtube channel. Do you enjoy our content? Rate our show! Follow us on Twitter @acquanon Learnings about small business acquisitions and operations. For inquiries or suggestions, email us at [e-mail]

Hey everybody, welcome to Deal Talk. This is episode number three. I'm with my co-hosts, Bill and Mills. Deal Talk is a weekly show that we do as a podcast between the three of us, and we look at Small Business M&A from a deal perspective. So we look at deals that we find, and those are either in the forms of teasers or Sims, sometimes anonymized, sometimes we talk about them, are able to talk about the specific companies. and we just think about how to think about the companies. And these are all businesses that are marketing themselves or trying to sell. So I'm very excited to do our third episode. And Bill, you have our first one. Yeah.

So this is a sim that I saw a number of years ago. And for context for listeners, our firm elements brands, we acquire direct consumer CPG brands. So typically my deals are in that vein. This is one of those. It was a direct consumer skincare and hair care. brand. A little on the smaller side. When we saw the SIM, they were doing about $181,000 of revenue and cash flow about $77,000. The business was six years old at the time and had been flat, flat,

so they had done for the past three years almost exactly that same $77,000 in profit. They carried very little inventory, about $14,000 of inventory, or about $19,000 of inventory on average, and it was just run by the two founders, or I guess the founder and her husband, out of their house on the West Coast. They had kind of one contract manufacturer or two contract manufacturers, and it was pretty much as simple as the products were shipped to their house in five-gallon buckets, and then they bought bottles and labels. And then when you order one, they filled the bottle with a pump, slapped the label on it, capped it, and mail it to you. So it was fairly manual, small business, but decent margins.

You know, as I said, $77,000 in profit on 181 of sales and very stable. I have been stable for six years since founding. The founder, she has started it because she was an ascetician, and the angle of this brand was, you know, kind of before it was cool, was really, you know, whole plants, no preservatives, no chemicals, kind of very high and higher price points. I mean, we're talking $25, $30 for a bottle of shampoo, but they did almost all those sales direct consumer on their website with a small amount on Amazon, but didn't really focus on the Amazon channel and no wholesale at all.

So, hey, Bill, when did you guys transact on this? So this would have been. Yep. So you're showing my hand, which is that this is actually a business that we bought. I wanted to bring this one to the show because the past couple of weeks, I feel like we've been a little negative on the brands we reviewed. So this is a business that we purchased in 2013. Okay. For Elements brands. So we have since sold it. We sold it earlier this year. Just because it was a little small for us, our focus has moved up market to brands with about, you know,

between two and 10 million in sales. But we bought this one in about $181,000 in sales and sold it at about $600,000 in sales, roughly, after about five years of ownership, or I guess, nearly seven years of ownership. And during that time, it was a great cash flow asset for us. It really, this was the first acquisition we did actually, and it really helped me to build the firm on the cash flow that this brand generated at close, but also the, we were able to grow it. We were able to about triple it during the time we. So I know a lot about this brand, but I know Michael and Mills, you guys don't. I'd be interested in your takes kind of first before I get too far into it. Well, I was just going to say, Bill, it looks like it's, you know,

predominantly female, right, in terms of the consumer. It says like maybe 90, 95 percent. And they've got what looks like incredible, you know, return customer, 60 percent, you know, sales from return customers. And the average ticket price seems incredibly high. Over $70, which, from what you're saying, it doesn't seem like they have a ton of different skews. But is it just a higher price point, you know, shampoo or product for the most? Yes. Just just a premium product. I mean, they're a, essentially growing herbs and squeezing them into the bottle. You know, very fresh, just higher price points.

So that $73 average ticket price, that would represent kind of two to three items. Okay, gotcha. And what about like the differentiation of the product itself? Is it something that's just very hard to replicate then? You know, because I'm thinking there's not anything proprietary about kind of getting the raw ingredients and squeezing it into a bottle. Is it just that it's so manually intensive the other people? people are going, I don't want to mess with that.

Honestly, no. There is very little, and this, despite what lots of people who own brands will tell you, most CPG brands have almost no IP outside of the brand itself. Almost any product and any formula can be very easily replicated by a contract manufacturer, almost exactly or exactly to the point where a consumer can never tell the difference. So most brands, most companies here, the value of the differentiation, is in their positioning and their brand story. There's very little typically proprietary IP in most CPG deals.

This seems like it came about at a time. I mean, they started in 2006. You came in 2013. It seems like they did a great job of being early to this kind of natural, you know, natural kind of approach to skin care and whatnot. Yes. And then it seemingly has gotten very, very crowded since then. And so interested in your perspective on that as you're considering your investment thesis in this business.

Yeah. So that was partially our investment thesis in the business with that this was a growing category. What's interesting is kind of the growing category thesis, you know, oh yeah, I'd love to invest in businesses with growing categories. Something that we got wrong a couple times early in our history is thinking that, oh, when a category is really explosive, if you're early to it, it, that's a good thing. But there's a double-edged sword to that because that means that all of the established players come piling into your market at full speed, lower price points, huge marketing budgets, and things get very competitive, very fast, which not only arose your margins, but erodes your reach and your ability to stand out. So that was partially what happened to us

with this brand. And we did very well on it. I mean, we were able to triple it and reap a lot of flow and we sold it for a higher multiple than we bought it for, you know, by all Excel metrics, this was a smash of an investment. But we only got it to 600,000 in sales. And that was because, you know, kind of the whole, everybody came into this market and it became much harder to differentiate. So if you are buying a business that is in a market that you think is going to explode, you should have a pretty clear thesis, which we really didn't when we bought this brand. You should have a really clear thesis on how you will continue to differentiate. if everyone comes into your market. And that, and that, I think, is why that we were not able to make this business bigger, even bigger than we made it.

It is interesting. It does look like the biggest part of the asset you actually bought was their place in Google, right? I love, in this SIM, there's page number 11, which, by the time, the SIM is so old, they're still have it on 8.5 by 11 pieces of paper, right? That's the ratio. It doesn't look like a slide deck. But all of these different organic keywords, that they're one, two, or three are mostly ones for them, like organic hair products, organic eye cream and stuff like that. So that seemed like a big asset at the time, or am I overvaluing that? That seemed like an important asset, but even more so than that was the repeat customer rate and the email list. So they had, as Mills mentioned earlier, 60% repeat customers. So more than half their sales came from somebody who had bought before. And that was incredibly attractive to me because typically, you know, with these consumable products, you will pay a lot to acquire somebody up front and then you really make your money on sale two, three, four, five,

if you can get them to stick around. So I was really impressed and thought it spoke to the strength of the brand that they were able to retain people. And I will say, this is something I was very right about. That number remained the same for the entire duration of our ownership, in fact. This is a brand that once people found it, they just absolutely loved it. The thing that we struggled to grow in this brand is that the high price points, kind of 30 bucks for a bottle of shampoo, you know, very, and with the positioning of like very organic, you know, as I kind of say, facetiously, they squeeze the herbs right in the bottle. You know, a lot of people don't care that it's that organic, like 10 out of 10.

A lot of people will buy 8 out of 10 organic at half the price. and that was something that we struggled to articulate to the customer, which is why we only made it three times bigger. Interestingly enough, it's good that they had that high repeat level because I go look on Google now for these search terms where they were first, and they're not even in the top five pages after you get past the ads. Yes, like I said, huge amount of competition piled into this space. Yeah, that's absurd.

Bill, did you guys keep the branding as is? It looks like very kind of homespun branding. And granted, this is also a little bit dated, you know, when you guys acquired it and when the sim was made. But did you guys keep the same name? Did you update the branding, update the website, those kind of things? So we kept the name because, you know, when you buy a CPG brand, the name is essentially all you're buying. As I, because as I mentioned before, very little IP beyond the brand. So we kept the name. And then what we did is, you're right, it's very, it looks kind of very homemade, the branding in this sim. And so what we did is we surveyed the customers, is that we're going to update this brand.

survey the customers, we said, what is it that you associate with this brand? We said, is it the script font of the logo? Is it the blue bottles it comes in? Is it the gold labels on the blue bottles? Is it certain phrases or, you know, taglines? And overwhelmingly, the thing that they came back with was we identify the blue glass bottles with this brand. So because of that, we just changed everything else and kept the blue bottles. So we iterated the labels, the logo, all of that stuff to kind of freshen it and but kept the blue bottles so it felt continuous to people. And that, I think it's still, you know, kind of seems fresh today. Good on you guys for checking that and making sure, because you may, you know,

you could have haphazardly gone in there and been like, oh, these blue bottles look so old, you know, let's put a, let's put a, you know, cool packaging together. And then all of a sudden customers are like, oh, I'm like, you know, you could be the same stuff in the, in a different container and all of a sudden your customers think that all the value's gone. Yep. Because as I said, the whole value is the brand. And if you lose the trust and the association in the consumer's mind between this visual look and what's in the bottle, you're basically starting over. Can you tell us, Bill, I guess, about who the buyer for you was and what made you go about thinking about, hey, it's time for us to exit size being a factor. But I'm curious about

kind of the next phase, right, in terms of somebody else taking it over and what was that process like? Yeah, so we decided to sell this brand kind of late 2019, and it was purely strategic for us based on size, because as I mentioned at the top of the podcast, we have moved up market a bit, and $600,000 in sales was easily the smallest brand in our portfolio. What we realized is it's about the same amount of effort to run a larger brand as it is a smaller brand. So, you know, if you're going to send an email and it goes to a million people or 100,000 people, it's pretty much the same amount. amount of effort to press send. And that scale kind of translates across a lot of digital marketing. So we on purpose actually shed our three smallest brands over the course of the last year. So we went to a business broker, one that we like that sells e-commerce businesses, and they helped us kind of put together perspectives, reached out to their network. And we ultimately sold it

to kind of ironically full circle a guy and his wife, just like who I bought it from, who are going to take the brand from here and hopefully grow it and do very well. well with it. What did you do, Bill, in terms of the just day-to-day operations? If you had this husband and wife, what was replacing their role like, you know, post-close for you? Yeah. So that's a great question. So as I mentioned, they were doing it at home. And there's just the two of them. And they were by hand putting stickers on bottles and pump, fill, pumping them by hand, you know, into into jars and things like that. So when I bought it, I actually did that for about three to six months in my basement in Colorado where I was living at the time, which is important, I think, when you buy a business to

actually get into it and see how it's done. So I would, you know, wake up, I look at the orders, I manufacture the products to fill the day's orders, and, you know, I worked in my basement for a couple months. But in parallel, we ultimately ended up finding a third-party logistics facility who was willing to do kind of some of this hands-on kidding. And so I ultimately outsourced it to this 3PL. I, you know, I flew out there. I trained their staff on how to do it because it wasn't rocket science. You just had to kind of had the billed materials for every item, you know, know how much, you know, fill it by weight and roll on. So that's how we ultimately did it. And then I was able to focus on just the marketing and growing the brand. As I mentioned,

this was the very first brand that Elements Brands bought back in 2013. So at the time, I was doing nearly everything. So kind of after I was able to get the operations outsource, that's when I could focus on growing the brand. But it was critical to have the operations on lock. before we could grow it. Super interesting. So what, you know, what, as you think back on you looking at this deal before you did it, what surprised you that you didn't know at the sim time that you would, you know, go back and tell, you know, young Bill, hey, look out for this, it's going to bite you in the butt?

Just the level of expertise that was required in this market. Because as I mentioned, this was a very, very high end, very enthusiast. kind of skincare and hair care market. And I, you know, at the time was not a skincare and hair care enthusiast. But I figured, oh, you know, it's just a widget. You know, I can sell it. But it was actually a much longer learning curve that I expected to really get in the head of the customer and to understand why they were buying a product. And you can't, until you understand that, you can't go find more customers that are like the customers you already have. And actually, you know what, this is a great kind of anecdote that'll make you chuckled, but really illustrates the point. When we bought the brand,

they were making, they made a shaving cream. And when we were redoing all the packaging, we also rewrote all of the blurbs, you know, kind of the description of the product on the back of the bottle and on the website. I took a crack at it and I said, you know, great for, you know, daily shave, you know, leave your face feeling soft, you know, et cetera. And I had my mom review all of them, you know, because she was like squarely in the target demo. So I said, mom, please read these, see if they make sense to you.

And she goes, she goes, honey, this product is for shaving your legs, not your face. And I had totally missed it because most of the demo of the brand was,

you know, middle-aged women who are shaving their legs, not their faces. Like there were very few male customers, but because I was not yet empathizing with the demographic, I had totally whiffed on that. So that kind of illustrates,

you know, how long it can take to get up. the curve. That is so awesome. All right, great job. Mills, let's go on to deal number two. You have that one. Yeah, that's good. Bill, thanks for sharing. This is a sim on a residential solar company. So they do sales and installation of solar panels that go on people's, the roofs of their home. They're based in the Western United States. 2019 revenue was around $50 million, $209,000, EBADA, around $11 million, and they're projecting 2020 would be 65 million in revenue and about $14 million in EBDA. Their growth historically has been incredibly rapid. In 2015,

they were doing around $5 or $10 million in revenue. So historical growth has been pretty significant. In terms of forward-looking growth, they kind of tell this story about, look, we can expand into new markets. They've really focused on one geography. And they anticipate that they'll get, you know, a fair amount of scale and benefit from leveraging the processes they already have in place. Their customer type is all residential. There doesn't seem like they're doing any commercial or industrial or municipal. And it's majority owned by the one of the founders who wants to exit. But it looks like there's maybe a co-founder who would stay involved and then someone else on the cap table who owns a very nominal amount of equity.

They've got over 100 full-time employees, but then they interestingly have an army, several hundred folks who are in direct sales positions. I don't know if you've ever been spammed by somebody selling. You know, hey, free, you know, solar console for your roof, but I think this is those folks, you know, in this specific geography. It's an interesting company, you know, at face value, you look at this and you go, wow, this is a huge amount of revenue for what they do.

It's a pretty significant EBITDA margin, over 20% EBITDA margin. But there are a surprising number of these in the market has been my observation over the last several years. And I think it's a little bit of, you know, an arms race to see who can kind of get the most market share by whatever time interval. And so you look at a company like this and you think, wow, this is pretty differentiated. there are dozens of these. I mean, dozens and dozens. So it's hard to parse that out just by looking at this one sim. But when I kind of zoom back out, this is a fairly crowded space.

The way that this actual company works is a little bit, it seems very kind of simple at base value. Look, they call you, we'll sell you solar panels, we'll install them on your home, and it's going to lower your electricity bill. It's actually much more complicated than that because most of these companies, They actually, you don't pay anything to get the solar panels. It's anuitized by this company in the sense that they usually finance it for you. And it's all driven by this mechanism called a power purchase agreement of PPA. And so this company basically sells you, you know, for very little or almost nothing sometimes.

They sell you the solar panels. They install them on your house. And then they take possession of these PPAs and they sell them. to a syndicator. The people who end up holding these PPAs get a pretty significant tax credit. And this is one of those risks where a flag goes up in my mind, but it's incredibly regulatory sensitive. The solar tax credit program could theoretically go away overnight. It's been phasing down from about a 30% tax credit to 26%. Soon it's going to be a 22% credit. But all that to say, all that benefit flows to the person who ends up holding the power purchase agreements.

It's a fairly capital intensive business, which I've seen from this company and a number of others, because they're basically coming to you and saying, hey, look, we'll finance these things for you. So, you know, it's about 50% gross margin. The actual collection of revenue and cash flow, when you get down to it in some of these companies, you know, they could have very, very big EBITDA numbers, but the actual free cash flow on the statement of cash flows sometimes, you know, is just indentously small. One thing to note on this is that especially with these solar installation companies, the EBAA adjustments are sometimes just astronomical.

So, for example, on this one, about 50% of the EBITDA is in the form of adjusted EBITDA, which you've got to parse through it, but at face value is a little bit of a concern. some of them are okay. Some of these things are like, hey, look, the owner got a free solar installation on his house. Okay, that would probably be a benefit that flows to me as the owner of this company. Those are real dollars. Like, for example, if you see somebody who's paying $400,000 a year to upkeep their yacht,

if you own the business, that's real cash that you're going to collect. Some of the others are a little bit more suspect and I would say are kind of pie in the sky. things like when we stop sourcing products from a certain country, here's going to be the increase in our margin. If that's the case, this is me being the skeptic, then why haven't you done this already? Or, hey, look, we've got this massive, in this case, it's about a $2 million a year discretionary bonus to employees. And they're saying, look, you can adjust this whole thing back. And that's just imagine that conversation with your key employees. Hey, congratulations. I'm a new womaner. We're really thrilled to be partnering with you.

And by the way, you've been grossly overpaid and we're going to bring you back down to market rates. That's not an adjustment that you could stomach. So that's the high-level overview. You guys feel free to chime in or tell me what you like or don't like. Yeah, this does feel like one, you kind of think about companies

of how much of their environment and ability to succeed is in their control. It seems like a lot of it is out of their control. Right? You have the supplier side. You have, you know, the other thing I think about here is the PPAs and the appetite for people to buy those as syndicators. How do you think about that kind of aspect of it, Mills? Or do I, am I thinking about that these guys actually have more control of their destiny than it seems like at first glance?

Well, no, I mean, to me, it does feel like they're in a fragile position. Now, they mentioned, you know, they referenced that there are many people who can buy these PPAs and they, work with some of the largest ones. And, you know, one of them is a publicly traded entity. I mean, they're not, you know, it's not like they're going door to door saying, hey, do you want to buy solar credits? But you're right. I mean, to me, in terms of where you sit in the value chain and how that, how those dynamics can change, I think companies like this can get squeezed pretty easily, right? I mean, if all the sudden tax credits change, if all the sudden syndicators decide they want to extract more value from you.

If a lot of new entrants come into your market, and all of a sudden, your margins on revenue are squeezed. You might be getting nibbled to death on the sale of these power purchase agreements. All of a sudden, your 20% of EVATOC could theoretically get very, very low, just in order for you to remain competitive. And this is, I mean, $50 million of solar panels is, that's a lot. Right. I mean, you're talking about a pretty significantly sized operation, but this doesn't seem like something that has a compounding advantage the larger it gets. Now, I agree, Mills. On the plus side, I think there is a certain type of buyer for whom this might make sense. Because as you kind of alluded to, this business model is not unique. You know, as we've kind of all been, I think probably spanned by people wanting to put solar panels on our house and do a PPA, et cetera. But if you are a sales executive, you know, you know, as we've kind of all been, I think, probably spanned by people wanting to put solar panels on our house and do a PPA, et cetera.

But if you are a sales executive or if you maybe already own a business, this would be a great add-on, if you were already in this business, if you felt like your edge was in scaling and sales and you wanted to buy a business where the business model had kind of already been figured out, right? There's lots of competitive. This business model is defined, right? You don't have to reinvent the wheel. But if you can sell and you can scale a sales org, you might be a able to do well with this. Now, of course, as you guys have alluded to, you're rolling the dice on all the regulatory risk in the meantime, but so is the rest of your industry. If that's a risk you can get comfortable with, but you think that you're just a sales animal and you can build a sales org, you know, this might be interesting. Yeah, yeah. I think this business also is, they're a little bit of a victim of their own success. 11 million in EBITDA is, it puts you into this kind of pool where the buyer, just the pool of buyers is so small on an $11 million EB-D business. It's in essence got to be a family office or got to be an established

private equity firm. And I think a private equity firm would pick this thing apart. I mean, to me, a couple other red flags is you've got typos in the sim. You know, it's an incredibly redundant and repetitive sim. If you kind of go through these different sections, they're basically saying the same thing over and over again. In some cases, that can be a huge plus, right? Because people don't spend time on it and they kind of pass it by. But at 11 million in EBITDA, this is just, this would be way too big for an individual, right? Or even a group of individuals to pull together.

So I hear you on that, but I also think that they've been a victim of their own success. Yep, fair enough. One thing that really stands out looking at the SIM, and I think we talked about this last week, the Sims and the prospectuses will tell you. you a lot about what kind of culture you're dealing with and where they're strong and where they're weak. And what really stands out here is how much detail and thought is put into the sales and marketing, go-to-market aspect of what they're doing in the SIM versus all the other sections. It's like, okay, here's our playbook. Like, we've got these people in the Philippines. They do this.

Like, under sales and marketing. So I do think that that to me shows, hey, if you were wanting to, say, if you were a Nevada-based provider of exactly what these guys do, and you wanted to buy somebody who's going to bring a real high-velocity sales culture into your company, I like that aspect of what they're doing. You could see that making sense for somebody, but I totally agree with you. This is a hard new business to get into if you don't know, don't know much about it.

One small little detail that's interesting to note, this company, they ended up converting to a C-Corp, which is usually a little bit of a red flag when you're dealing with a C-Corp. In this case, my hunch is, and I haven't spoken to anybody at the company, but my guess is that they switch to a C-Corp so they could get qualified small business stock, which is a huge federal tax incentive. And the way that it works is you have to be a C-Corp to receive this tax credit, but if you hold the asset for five years, and there's a lot of if, so this is not investment advice for tax advice. But if you hold the Seacorp stock for five years, you don't pay any capital gains. And so my guess is that these guys made that, they made that shift and just grew this thing like crazy, right, in the five-year window. The timing kind of lines up with when they were founded.

And then, I mean, good on them, right. I mean, kudos to them. It just creates a little bit of a hurdle for a buyer to think about inheriting the Seacorp and ways to work around that. but it's very rare that you see a company, because they kind of have a timeline of their history, it's rare that you see a company start as an LLC and then switch to becoming an S-Corp, I mean, sorry, convert to a C-Corp. And that to me is probably the tell, you know, that they're trying to capture that tax credit. Yeah.

One thing I do like here is how, at least they claim, the majority owner spends not that much time on the business. I think they claim 10 to 15 hours a week, which for a, company the size growing this quickly is at least they're claiming they've built a pretty good management team and a good model around all of that. And it looks like they're paying these people that he does have on the management team, the president and folks like that. It looks like he's paying them in a good market rate to be able to attract some good talent. So initial impression is, oh, this is probably a pretty good team and a very sales driven organization, which is good for an owner that doesn't necessarily want to buy themselves a job.

Yeah, yeah, great point. Cool. Anything else from you on this one, Bill? Nope, and that covers it. Yeah, look, hey, congratulations. We found two deals today that we didn't totally hate. Yeah. Yeah, yes. Hey, look, from a time perspective, I do not think we have time to do a third one today.

So I propose we wrap it up here. You know, we went for quality over quantity today, which turned out fantastic. Yep, sounds good. We'll leave it at two and wait for the next episode to dive in. So some more. All right, guys. Catch you next week.