Photo Credit: David Plunkert, Spur Design
Tom Kelly is no novice when it comes to buying other businesses. Two decades ago, the Portland, Ore.–based Neil Kelly Co. acquired a kitchen and bath dealership in nearby Beaverton. Four years ago it snapped up a similar outfit in Eugene. And last February, president Tom Kelly sealed the deal on Kitchen & Bath Concepts, in Bend, an hour southeast across the Cascade Range. For the firm, whose four divisions totaled $25.5 million in revenue last year, this latest purchase presented an opportunity not only to expand geographically but to hit the ground running with clients, trade relationships, and proven managers in place.
Remodeling companies aspiring to grow can go about it any number of ways. They might add services to an existing company, start from scratch in a new region, create a joint venture with another firm, or set up a franchise. But for many company owners, tapping into the capital assets and intellectual property of an established entity is the best way to go. For one thing, it minimizes the risk of expanding into a new market. The other business has a handle on local conditions, from understanding competitive pressures to what drives consumers to how the supply chain works. That said, it takes a dispassionate eye to judge the merits of a merge. “The greatest mistake business owners make is that they get an idea they want to purchase a certain company, and then look for the rationale afterward,” says business consultant Stephen S. Little, author of The 7 Irrefutable Rules of Small Business Growth. “They let emotions play a greater role than they should and tend to ignore things that would say ‘red flag.’ They need to look at the purchase logically and with outside expertise.”
A Good Fit
The deal-clincher is different for every company. At the top of Kelly’s criteria list was the quality of the other business’ reputation, and that’s true for each purchase he has made. Although profitability figured into the decision, Kelly planned to re-brand the other firm and revamp its business systems, so its repeat-client and business relationships are what he valued most. In fact, Kelly never intended to buy a business in Bend. He wanted to build a new showroom there, capitalizing on the name recognition he’d planted through statewide advertising on National Public Radio and in Portland’s newspaper The Oregonian. Kelly contacted the Kitchen & Bath Concepts owner — a long-time dealer for Neil Kelly Cabinets — as a courtesy to let him know that he wanted to expand into that market. Serendipitously, the owner was in the process of selling the business to retire. “We knew this person fairly well and we had always been paid on time,” Kelly says of his attraction to the company. In addition to the client list, the purchase included some vehicles and a showroom, which Neil Kelly Co. is remodeling from top to bottom.
Acquiring a company can be an integration nightmare, though, making roll-ups a challenge to run. Kelly is reluctant to expand into new markets without long-time employees who are willing to run the branch. In this case, he sent over a sales manager and a designer from the Portland office and hired two additional people for the new location. He also interviewed Kitchen & Bath Concepts’ three employees — a designer/salesperson, a carpenter, and an office manager — and hired all three to stay the course in Bend.
“One of my biggest concerns is always whether the people who work in that firm will fit the culture,” Kelly says. “I’m a real believer that you want to give everyone a chance to stay if they want, but be prepared to find out that some of the people and traditions may not fit.” To speed the transition, the original staff received routine orientation and training specific to their job. As Kelly has discovered, when the shoe fits, the advantages are immediate and long-lasting. “One of the top project managers from the company we purchased in 1988 came along and is still here, so there can be some huge benefits from that perspective,” he says.
Photo Credit: David Plunkert, Spur Design
Value Judgments
Indianapolis remodeler Geoffrey Horen experienced different growing pains when his company, The Lifestyle Group, purchased Square Deal, a window, door, and flooring company in Crawfordsville, Ind., nine years ago. The opportunity came when his business was in startup mode, and CEO Horen admits he probably broke some rules by adding on before his own company’s identity was fully formed. The goal was not to expand to Crawfordsville, a small town an hour away, but to fast-track the supply chain. “Ideally we were buying it for growth but also as an investment for what we ultimately wanted to do, which was to provide a one-stop shop to our clients and eliminate the middleman,” Horen says.
The jump-start allowed The Lifestyle Group to grow from zero to more than $2 million in four years, but managing the store from a distance was a logistical and cultural puzzle. “We were trying to figure out what we wanted to be, and at the same time trying to run a second company and merge it with what we wanted to build,” he says. “We were trying to grow two things that weren’t a lot alike.” After 9/11, when business flattened in Crawfordsville, Horen brought the branch in-house. A few employees were absorbed into the Indianapolis operation, including a top-notch carpenter who still commutes today. “If you asked me now, would I buy another remodeling company to grow, it’s difficult to know because the value is in the client list,” Horen says. “Most of the time you’re buying people. If the owner goes away, does the opportunity go away?”
It’s a question that Seymour Turner, executive vice president of Chicago–based Airoom has also asked himself. Two years ago his company considered expanding geographically by acquisition. But that idea is on hold as the company refocuses on the Chicago market. “Our core business is complex, requiring 13 trades and a knowledge of local codes and permitting,” he says. “We felt that taking it on the road would be difficult.”
For now, Airoom is adding exterior renovations, home electronics, and energy assessments to its repertoire, with the possibility of spinning off its exteriors segment in other markets. In valuing an acquisition target, Turner tries to calculate the amount of time and money it would take to soak up another company’s knowledge, and the depth of its management layer. “In a classic partnership acquisition, we would look at what they have on the ground in a management team, and how many might stay,” he says. “The reality is, a lot of businesses are managed day-to-day by the owner. Someone looking to retire would not be of interest unless he had a good manager.”
Due Diligence
When the stars do align, there’s still the matter of making an offer. How much is a business worth? The typical valuation for a service business — one times revenue plus inventory — doesn’t apply particularly well to remodeling, since many small companies largely rely on their owner’s participation. There are armies of experts to help remodelers arrive at a number when it’s time to sell. Most want to see accounting records — several years of financial statements, tax returns, a payroll register, a budget for the next year, and an organizational chart. But they also want to know something about the management team’s background and experience. In preparing a starting number for negotiations, Kelly figured out what he might save from coat-tailing on the new company versus starting from scratch, plus what the customer list, building, and vehicles were worth.
“The best indicator is: How likely is it that I will retain the past customers?” Little agrees. “What’s the other company’s average length of customer retention? What’s mine, and how do the numbers compare? How much revenue does this customer generate per year, on average, and what is the lifetime value of that relationship?”
Kelly’s three-month-long due diligence process involved poring through three years of CPA-prepared financial statements and getting client and trade contractor references. And the deal was structured as an asset purchase; he wasn’t taking on payables and receivables or liability for warranties or prior work. In the end, however, it was intangibles such as reputation and creativity that were key.
The soft economy notwithstanding, the Bend operation is roughly meeting projections. “We planned on an additional $800,000 in revenue for this year in Bend,” Kelly reports. “We intend to do $1.5 million next year, and $3 million in three years. Due to the economy, we are seeing some decrease in overall sales, but we are still having a strong year.”
Cheryl Weber is a writer in Lancaster, Pa.