Acquisitions Anonymous - #1 for business buying, selling and operating - A niche motorcyle accessories manufacturer - A falling knife e-commerce business / e15

Episode Date: January 25, 2021

Back to talk two small businesses for sale this week:- A niche motorcycle accessories manufacturer - A falling knife e-commerce business / S1e15-----* 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 Group--- Support this podcast: https://anchor.fm/dealtalk/supportSubscribe 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]

All right, everybody. Welcome to Acquisitions and Anonymous. We took the week off last week for good reasons. We were too busy doing other stuff. But again, I'm Michael Gurdley. I am here with my co-host, Bill and Mills. And we have two companies that are for sale today to talk through. And I have one.

And then Bill will follow on with the other one. So let me get started with the first one. And then let's talk about it. So this one is a Canadian company. It's actually a listener submitted one. So thank you guys. for sending us deals to talk about, keep it coming. So this particular listener has been looking at the deal for a couple weeks,

and I'll read a bit from the teaser. So here comes the broker speak. This is an opportunity to acquire an motorcycle accessory manufacturer with custom manufacturing capabilities. The company has a manufacturing facility and a distribution and warehouse center serving the North American motorcycle enthusiast market. Over the last number of years, the business has focused on building a brand known for its product quality,

an excellent customer service. Through constant investment in R&D, the business has continued to focus on product development and design innovation. That's a mouthful there. That sentence should have paid on Fiverr to fix that sentence. The company produces customized products for all top motorcycle brands and makes,

including Kawasaki, Harley-Davidson, Honda, KANAM, Indian, Yamaha, etc. They sell through online forums, magazines, trade shows, and social media channels. So this sounds like it's a bunch of aftermarket stuff. if I'm thinking about this the right way. They've grown to be one of the top manufacturers in its industry niche with a loyal customer base

across North America. Customers are generally not price sensitive, probably because they're Dennis driving around Harley Davidson's. It doesn't say that in the teaser, but that's Gurdley telling you what I think. And they're able to charge a premium compared to competitors due to superior quality and excellent customer service.

In addition, they have long-standing relationships with suppliers and established supply chain and distribution network across North America. pretty consistent financials. We don't have Euroa year because we're just teaser, but they've been running at gross margins about 30%. The business itself is listed at doing $3.3 million a year in revenue. EBIDA in the $707,000 range. So EBIDA being earnings before interest, taxes, depreciation, amortization, and the seller's discretionary earnings is $787,000 a year.

And so, let's see, the SDE, so the seller's discretionary earnings, close to $800,000, they want $2.5 million for it. I'm assuming these are all Canadian dollars. So if so, you've got to discount them by about 25%. So our listener has been looking at this deal for a couple of weeks. He thinks it's kind of priced highly. I guess, I don't know, look, it doesn't look that high to me at three times SDE, but I'd love to hear what you guys think. They sell mostly in America. Well, it's interesting.

Our guy, when he looked into it, thinks that these numbers here are probably optimistic. And as he dug into the finances aren't exactly as high. He thinks that EBAA is down closer to around 500K than 700K. Yeah, and that's about it. Unlike other manufacturing, I'd be interested in digging this. He says it's not a capital intensive operation. And he does think it could be made more efficient.

But yeah, so I'll pause there. There's, according to him, also the listener, There are other specialty folks out there. Mustang and Corbin names come to mind. And there's some competitive pressure there for other folks going against this market. So I will pause there. Also, this person says he likes my no BS style on Twitter. So in your face, guys.

So we have a somewhat bloated, questionably financed, represented Canadian manufacturer of aftermarket motorcycle accessories. What do we think? I mean, I like the market. like motorcycle access aftermarket generally of automotive is a huge market. There's a lot of them out there. Depending on what these specific accessory is, I think you can do pretty well with it. I've seen a lot of really nice automotive motorcycle ATV aftermarket parts businesses. One thing that jumped out at me about this is their margins based on kind of what our listener told us their gross profit margin is a little under 30%. And their adjusted EBITDA margin is 17.

But he says ad backs represent about half of that adjusted EBITDA. So maybe they're real EBITDA margin might be closer to 10%. And this just feels, you know, without knowing a lot about this business, this feels really thin. When you're running on a gross profit margin of, you know, 28 to 30 percent, there's just not a lot of room for anything. There's not a lot of room to screw up. There's not a lot of room to do advertising.

There's not a lot of room to hire for growth. you know, low gross margins are just hard-mode businesses and more power to the people that can succeed doing them, but those are not businesses I like. Yeah. Well, low gross margins are okay if you're in a mass market and these guys are in the quadrant, right? I think that's what you're saying, right? If you're in a niche and low gross margins, like you better have a cool niche. It's just hard. It's just hard, man. You better, you better be getting a lot of fun and gratification out of this business because you're going to work hard for every penny. Yeah. It is interesting that the brands that they list here are all kind of the cruiser brands,

you know, the hogs. So there's a couple things happening in that market, right? All of the boomers who are interested in buying hogs? They're starting to get too old to drive around on hogs or they already own them. So Harley's been getting just brutalized in the market. And our generation, the Gen Xers and millennials, like how many of your friends are like, you know what I really want? I want an electric cruiser. Like, nobody wants an electric cruiser at our age. So there's headwinds, I think, around this. And then the type of aftermarket things you buy here, like a leather, a leather, whatever the pouch you put on the back,

that stuff lasts for years. It's not like this is a consumable either, which is another worrisome thing for a manufacturer. So Mills, you look like you have something to add. Well, I mean, I always think about, you know, on things that are e-commerce related like this, what's the role of the brand, you know? Are these like highly branded, highly distinguished? kind of innovative products, or are they fairly generic? It's like, you know, leather saddlebags

that you couldn't necessarily tell from, you know, a knockoff or a competitor. I would be really curious about that, and we don't have that kind of information on this, but if it's a, if it's a very kind of unique, I don't know, like if it's a windshield, right? And it's a very special windshield that you, you know, exactly what it is when you see it and it's incredibly differentiated and it's all the rage. Like, that's a little bit different. than just, you know, I don't know, I mean, it could be anything, right? It could be accessories for the bike. It could be decorations for the bike.

It could be gear that you wear while you're on the bike. I mean, all those things kind of have, I think, different attributes that may be more or less appealing depending on how the brand is positioned. I do think it's worth bringing up, though, this idea of ad backs. And I feel like I've just heard more and more people have very polarizing opinions on this. and I think most people come down on it's a major red flag to them if there's a lot of adbacks. So what's an ad back, Mills? So the ad back is in this case, the seller's trying to represent, here's kind of the true

earnings potential of the business if I didn't own it and you owned it because I'm going to, you know, pay for my wife and kids health insurance or everybody in my family, all my kids and grandkids, they get gasoline through our, you know, our fuel buying program or whatever it may be. But the issue right with this is that every seller wants to add back a dollar because they're hopefully going to get three to five dollars worth of purchase price in addition. But I will say, you know, I think people maybe take too visceral reaction, at least that's what I've run into recently and talking to searchers or people who are looking for businesses to buy is that they're like, oh, you know, this major red flag, all these adbacks. And I would just say, if they're real adbacks, I love it. I remember looking at a business that had a $600,000 a year boat expense. And I just thought, that's fantastic.

I love that. We're not going to own a yacht. So I know that every dollar of that goes to the bottom line. So I'd be curious what you guys take is, do you have that kind of red flag and go, oh, I hate this or you see it as maybe true earnings? I mean, it really depends on when you dig into what it is for sure. I do think that this is a lesson learned for business owners. If you're planning on maximizing the enterprise value of your deal,

like run your business like a real business. Don't treat it like a piggy bank. That was something I had to learn the hard way. Don't do stupid stuff like put a boat. I know it's going to save you some on taxes, but it's a total short term move. The other thing I hate about it and when you treat your little business like a piggy bank like that is it sends a terrible message to your employees.

You're like, this is not a professional environment. And that is precisely the opposite of what you want. want your employees to think. So yeah, I would love to see more deals. If I was a seller and I wanted to make more money, like I'm going to run my business for a few years without all that ad back crap. And I'm going to be a real professional. But that's me. Yeah. I think it's important also to talk about a second category of ad backs. I mean, I think we've been discussing the kind of the discretionary income ad back, like I have a yacht in my business for tax reasons or I'm running my family's minivan through it or whatever. The other type of ad back is the always infamous one

time expenses that you see so often where, you know, the seller will say, oh, well, you know, we bought a whole bunch of new trucks last year and we don't need to buy a whole bunch of new trucks this year. So that's a one time expense. So we're going to add that back or, you know, whatever it might be. And you go, or failed R&D. That's my favorite. We spent $300,000 on R&D and and it didn't pan out. So we wanted an adjustment for that. It's like, well, why are you bad at R&D? And what does that tell me about the ability to put new products in the market, you know? Yeah. I mean, most brokers, honestly, like if a broker is worth his salt, honestly, they will try to go for, they'll load up the adbacks if possible, right? Because they represent the seller. So you as the buyer, you know, you should put a big old bullseye on every single one of those ad backs. And my position is the ad back is bullshit until proven otherwise. You know, any one time, any anything like that. I mean, if it's obviously a yacht, like, okay, I'll allow it. You know, but if it's failed our or if it's, we bought a whole bunch of new trucks, well, I'm going to have to buy a whole bunch of new trucks

again in five years. You know, so we should probably amortize that. Or, you know, hey, we redid our website last year and we're not going to do that again this year, so we're going to add that back. You know, you'll see a lot of very aggressive one-time ad back. So you've got to really hawk on those. Yeah. So it sounds like we generally think this is not a terrible business to be in, but our first impression is one where the broker may appear to be pulling some shenanigans to make it look more appealing than it really is once you look under the hood a little bit. Yeah, I mean, with a high 20s gross margin, I would not expect an EBITDA margin of 7%, or 17%, I would expect an EBITDA margin of closer in the single, in the low single

digits, right? Because there's just not that much room below gross margin. So it kind of doesn't shock me to see a gross margin of 28% and an EBITDA margin of 17%, and then to say, oh, well, half that EBITDA is adbacks. Well, yeah, that kind of smells right. Plus, who wants to go to Canada anyway? Oh, wait. Oh, sorry.

I just lost all of our Canadian listeners. I'm very sorry. No, Canada's great. Okay, let's move on from this one, if that's all right with you guys. Bill, over to you. Yeah, so our next deal is an interesting one. As our listeners know,

we specialize in consumer products, lotions, potions, potions, shampoos, laundry detergents, pet products, things like that. And we recently chatted with a company, who obviously shall remain nameless as per the theme of this podcast. But it was a cosmetics brand and great brand. I mean, man, I just love their branding. They had gotten a ton of really good PR. Several years ago, they had rolled out in Target and, you know, a couple other big box retail to much

fanfare. And I remember seeing when they rolled out and going, damn, I really love that brand. Like that's, it's just super well done. You know, I would love to buy that brand someday. and behold, we got introduced to them fairly recently. They are for sale. And this deal, I don't mean to kind of rag on this deal specifically, but this deal is emblematic of a category of deals that we see a lot, which is kind of great brand, startup brand, rolls out at retail, does okay, but doesn't realize how expensive retail is. So this business, despite being in thousands of national retail doors for four years, which means they're selling through, they're not getting kicked out, is doing kind of three million or so of sales and like

very consistently, you know, the whole time. So like they're moving through at retail, but they're not growing. And it really highlights how little money, you know, entrepreneurs will really celebrate, oh, I got rolled out at, you know, at Walmart or Target or whatever. But you don't necessarily make a ton of money because this product, you know, I happen to know kind of what goes into it, and their gross margins, if they were selling direct consumer online, should be like 90%. It's a really high margin product, but their actual gross margins, when you look at their P&L, are closer to like 50 or 60%. And that's really not even a fully loaded gross margin, because you also see them getting creamed on all of these commissions and billbacks and, you know,

big box related fees. And so when all said and done, they're losing nearly seven figures a year on about $3 million in sales because they're just not, they're not moving enough volume. And then, to make matters worse, there was a pandemic last year,

which really hammered retail, right, obviously. So all the retail stores, foot traffic got crushed. So they basically lost all that revenue. So now they're down to, essentially only their direct consumer revenue, which is like about half a million bucks. So kind of they came to us and said, hey, we'd love to sell our company. And I said, great, you know, kind of when we felt around for valuation expectations,

we found out that they had raised several million dollars, which meant that they felt as though their business was worth a multiple of the capital raised. And, you know, this is sort of the problem we've joked about in this podcast, a few, other times, which is my business is worth my mortgage balance, right? Or my business is worth, you know, some number that makes my investors whole and I got to make a little bit of money. And it's just not even close. I mean, it's not even really worth anything. And so, you know, we kind of, we ended up as stalemate. So I'm, I'm interested to hear what, you know, Michael and Mills, if you guys have seen businesses like this, you know, what you thought about

this specific one. I uploaded the P&Ls to our share drive so you could take a look. Yeah, I mean, I agree. You look at this and you think, gosh, they've got almost $3 million dollars worth of preferred stock out there. And so the common is basically out of the money, you know, for any transaction, probably probably at their normal sales levels, right? I mean, even if they'd stayed at two and a half to three million dollars top line, one question I have built, were they full chain at Target or was it just across certain doors? They were almost full chain at Target, which is pretty shocking that they weren't bigger.

Yeah, yeah. I mean, that's really, like were they selling toothpicks or Q-tips or something that, like, like people buy once every 10 years. No, their average selling price is like 15 bucks or so. So like really not bad. Yeah. I mean, I think it would be helpful, Bill. Maybe we've talked about this some of the past, but you alluded to fees, right? I feel like it's this idea if you have a consumer products brand that it's like the, you know, the golden goose is if I can just get into a Walgreens or a target or something like that. But the, you know, chargeback fees, slotting fees, mark down dollars, like the dynamics of all those. I've seen when I was doing more sell-side MNA work,

I saw businesses, you know, get a million-dollar purchase orders and lose money, you know, hand over fist, lose $200,000 on a true net basis because of some of these, you know, mechanics, right? And the reality is if you do business with Target, then they, they have the leverage, right? No surprise there. But can you comment on that? Yeah. So it's, it's brutal. It's devastating. So let's just go back to, you know, when this business had a normal year, we'll even go back to 2018. So in 2018, this business did over $2 million in sales, about almost like 2.1 million in sales. But after all of their contra income, their scan downs, they're off invoice, their promo discounts, all the stuff that Target got back from them, they are down to $1.5 million of net income after all that stuff. So you go from 2.1 to 1.5 just after you, you know, pay target all the stuff that you pay them.

And to clear that's net income. That's net revenue. That's net revenue. Yeah, exactly. Exactly. So they have $600,000 of contra revenue on $2.1 million. Yep. Yeah. And so like things like markdown dollars or trade spend. So like trade spend, I don't actually know what that is. What is that? So trade spend will be, you know, Target will say, hey, and not just Target, not picking on Target, any big box will say like, hey, we want you to be on sale four times a year. Guess just kind of table stakes. And when you, as a consumer, walk in and you go, oh, this thing's on sale, it's 20% off. You go, great, like, you know, Target put it on sale.

No. Target is not, guest who's paying for that, the brand. So Target, whatever that discount is, Target is billing it back to the brand and just taking it off their payment to the brand. So every time I like cry now, every time I'm in a grocery store or anything, and I see these small brands on sale because I just know the entrepreneur is just taking it into teeth on this sale. And there's other things like sometimes they'll require you to advertise in their circular, like the, you know, like a little newspaper they put, you know, the inserts that they put in your local newspaper. And they'll require you to advertise in there. Of course,

there's a fee associated with that. Sometimes that's trade spend. But then there's all these like returns and allowances. So like if you as a customer walk down Target and you're like, oh, I wonder what this thing smells like and you rip open the box and smell it and put it back on the shelf, guess what? Target doesn't eat that. The brand eats that, which really just always pissed me off because I go, you didn't take care of my product on your shelf. Like you're letting customers come in and damage it and I'm eating it. That's how the game is played. There's also slotting in free fill. So like, you know, a lot of Target stores, again, using Target as a stand in here, we'll say, you know, you're going to give us for every new

store we take you into, you're going to give us four free units. That's called free fill. And you just give it to them for free as part of their, you know, their incentive to bring you on your privilege for working with them or slotting fees. You know, they'll charge you, you know, per square foot, you know, to get put on the shelf, per square foot of shelving. I mean, the list is endless and nauseating. I'm just laughing. Look at it, Michael. Yeah, this is a terrible business.

Everything you've told me makes me want to run back to software. Yeah. Well, and that's the stark, and this kind of comes back to the elements, brands, business model is CPG in retail is devastating. And the reason is, is the retailer owns your customer, right? So they can bend you over with all kinds of fees because you need them to get to the customer. Meanwhile, direct consumer kind of flip that on its head and you can go straight to the customer and you cut back, you cut out all of this. So every dollar of revenue is so much

more profitable. Now, of course, you have other costs, you know, Facebook costs and Amazon costs, but generally they don't really add up to the same type of freight you pay going into wholesale. Wholesale, though, you know, in my view, has become phenomenal marketing. You know, if you want to be a real CPG brand, you have to do it to legitimize your brand, to get your brand in front of all the customers, the 80% of retail that is still done in person and not digital, even post-COVID. You've got to do it, but in my view, you really need to view it as a marketing expense or a break-even channel, not something to build your business and create EBITDA. One thing I'd add is there's some stuff in here that you can kind of see in P&O,

sometimes when a business appears to be run well and when it doesn't. This shipping discrepancies line here is really interesting. So I think I read that as, that means they sent stuff to Target or to the retailer and it was wrong when it showed up. So that means this is a company that's being run and not shipping stuff correctly out of their warehouse, typically a sign that other stuff is being done poorly as well. Yes. $35,000 in a single year.

Yep. Yes. Yes. You definitely want to watch out for that, although I will give them a little bit bit of credit. We do business with a lot of these guys too. And half the time when they bill us back for this stuff, it turns out that we were exactly on time and exactly the right quantities and they screwed up and we have to submit documentation and they reverse the chargeback. So like, I have an employee who used to work at a large grocer that you guys would know.

And he said that their gross margin on groceries is something like 11%, you know, a big box grocery. But he said if you eliminated all of the fees, all of the chargebacks, the slotting fees, the damages, all that stuff, their gross margin is negative on the actual food, which means that these retailers are not in the business of selling food. They're in the business of charging their brands fees. They're basically landlords and marketing companies. So, you know, when you do business with them, you just have to understand that. Yeah. Yeah. The other thing that jumps out here is, you know, there's this line item of fulfillment labor and rent that was, you know, over $200,000 in 2018 and goes to basically zero in 2019. And maybe they've moved it right to somewhere else

in the P&L, but it's not readily apparent to me. You know, things like this where you go, hey, look, there was some blood in the water. They tried to course correct. But what am I going to inherit, right, in terms of pent up kind of liability or debt that's a accumulated in some way, not just financial debt, but operational or organizational debt, that would be very, very worrisome to me. Speaking of debt, if you look at this company's balance sheet, you know, one other thing you will see is you look at the debt, you know, they've got a $300,000 promissory note, and I would be willing to bet dollars for donuts that is to the equity investors that had

to put more money in to float this company. So you basically got to count that as, you know, they've got a seed series, they've got a A stock, they've got an A1 stock, they've got the promissory note. I mean, you can just tell like, you know, the equity investors have been plowing money into this thing. The other thing that's kind of not always on the balance sheet I found in these small businesses, especially when they get to be distressed, is trade payables. So we once bought a business in 2017, and we found, we found two things. One, when we were closing down their office because they were basically bankrupt. We were selling their furniture. We cleaned out the drawers of their accountant. And we found $35,000 of invoices that had simply not

been entered into the financial system. So like literal desk drawer liabilities of $30,000. And we just had to eat because these were liabilities to their contract manufacturer. You know, like that's better than first lien debt. Like you have to pay that or they just go, okay, you know, no more skin cream for you. You know, you can't, you can't. You can't. your business is done. So one of our points in diligence, especially when they get distressed, is we either require a letter

from all of their vendors that says they're caught up on payments or we have to hear directly from the vendor that they're caught up on payments because that's the worst. You buy the business and your vendor goes, actually they owe us another $100,000 before you can order any more inventory. That brings up a good point, though, Bill. So in most, like, I would say traditional kind of non-e-commerce, non-in-net-related M&A, as a part of the purchase agreement, as a part of the reps and warranties,

the seller is representing and warranting, hey, we are in good standing, right? You're asking them to disclose anything and you know it. And then if there are any surprises, with most traditional M&A deals, there's a holdback of, you know, certain percentage of the purchase price that's held in escrow and the reps and warranties, any issues with the reps and warranties go against that escrow amount. But I feel like people I talk to who are buying online-based businesses, it's not necessarily as like belt and suspenders, if I could use that kind of description. But what have you seen on that front? Yeah. I mean, in general, online M&A is just less, you know, online, smaller M&A is less sophisticated, right? It's the Wild West in my mind.

It's the Wild West, right? And it means that buyers don't know to ask for these things, but it also means that sellers won't accept these things or even brokers will tell their sellers, I've never heard of this before, even if it's a totally common thing. And you as a seller hear from your broker, I've never heard of this before. You don't think, oh, maybe this is a two-bit broker. You think, this guy's done tons of transactions of my buyers being unreasonable, right? The other thing in this case is when the business you're buying is distressed, often there is not even enough total consideration that you will.

would hold back to cover any, you know, destrial liabilities, so to speak. So like when we bought that business in 2017, we bought it for assumption of debt. We didn't pay them anything. You know, we, we just took over their debt. So then when we found that $30,000, I was faced with suing an old lady personally, right,

or eating it. Yeah, I mean, like, yeah, like I had her, like she signed on the dotted line and she was a signatory to the asset purchase agreement. So I could have gone after her for that. for 30 grand, but like, you know, it's kind of, you pay, you structured into your price that you expect to find stuff like that. Yeah, yeah, great point. Well, so what happened? Oh for two today. Well done, guys. It has not yet been resolved. I don't know what, uh, what will happen to them.

If I had to guess, they will probably have to wind it down if I had to guess because the, uh, you know, as you said, Mills, they're in for the equity investors, you're in for about $3 million. It's not worth a shadow of that. There's really no way, when they get this messy, no one's going to buy the stock because there's so many unknown liabilities. They're going to have to kind of wind it down. They may sell the intellectual property for a couple bucks,

but this is probably going to end up a smoking hole in the ground. But Angel investing is fun, right? Oh, it's fun until it ain't. This is not fun for anyone involved, I promise you. Yeah, I agree. At least of all, the CEO, I'm sure. Yeah, founders. Great.

Well, I think we've wrapped up today. Hopefully next week we'll come up with some stuff that's slightly more appealing. The motorcycle thing was okay, you know, just a little pricey. Yeah. Cool. All right, guys. Well, great job. And we have special guests next week.

So, Mills, any hinting for the audience about that? Yeah, so our guest next week is going to help us get a peek into the mind of a strategic acquire, a true kind of strategic acquire within a very well-defined ditch. But it's service-based business in the southeast, so it checks every searcher's box, right? Every buyer wants a service-based business with decently high margins in the southeast is kind of a hot area. So we'll check a few boxes next week. All right. Well, I'm excited. Great job, guys, and looking forward to next week.