What to look for when buying a propane company

If you are a propane company in acquisition mode, there are several key factors to consider when assessing a potential target company.

The consolidation trend gripping the propane industry shows no sign of slowing. Despite borrowing costs that are significantly higher than they have been in the past several years, there is ample capital available for the right deals. Now seems to be a time of perfect confluence between propane marketers eager to expand through acquisition and sellers just as keen to exit the business.

Learn as much as possible

Before committing yourself financially – and emotionally – to purchasing a propane company, it is important to gather intelligence up front. The more you know about the true financial situation and value of a business you are contemplating purchasing, or merging with, the more you will reduce the danger of paying too much or owning unanticipated debts.

This is an essential part of the due diligence you should perform prior to deciding to make an offer. It will also give you the ability to enter negotiations armed with an accurate assessment of the company’s value. The best negotiators are those who possess accurate, timely information and know when to use it. Even if a merger is the approach you are taking, you should have an accurate measure of how much your potential partner’s business is worth.

Negotiations are more likely to go in your favor if you come to the table with knowledge of the value of the target business acquired by using one or more of these four key valuation methods:

1. Net asset value: This is an indicative value of the business as stated by taking the assets in the financial statements the seller presents and deducting outstanding liabilities to creditors or tax authorities, loans and other payments due. The net asset value provides a baseline from which to start the valuation process. What you need to consider is that these assets are not marked up to fair value. To get a net asset value that approximates fair value, you need to step up the appreciated assets – such as tanks, vehicles and customer list – to their fair value.

2. Entry cost versus cost of acquisition: How does the cost of acquiring the target business compare with the investment you would need to enter its market with your own company? Be sure to include assets to be acquired, product development, payroll and marketing costs. Are there savings you can gain through acquisition instead of introducing your own competing brand? If so, are they large enough to justify the purchase? A thorough analysis of the target’s operating expenses will help you determine where savings might be realized in order to achieve an accelerated return on investment.

3. Cash flow: Forecast the target company’s cash flow for several years and discount these numbers to obtain a net present value. If you are unfamiliar with this method, an accountant or adviser with experience in the mergers and acquisitions field can advise on how to choose and apply discount factors. Make sure you have the financing lined up to get through the finish line. It will probably be more expensive than you think and will take longer to break even.

4. Quality of earnings report: Net income is not the most accurate indication of financial performance of a privately held company. For example, a company reporting strong net income could still be operating with negative cash flow. A quality of earnings report evaluates how a company accumulates revenue, such as cash or non-cash, recurring or non-recurring. If a business reports positive net income but doesn’t have a substantially increased adjusted EBITDA, it may be a riskier investment than the company’s financial statement would indicate. These reports, while not common in the industry, should be used more for purchases of mid-sized to larger businesses to have a third party go in and evaluate the quality of the EBITDA that is presented in confidential memorandums a buyer receives when making an acquisition.

Other factors may figure into your calculation of value and impact your negotiating position. For instance, a propane business run by one person has a perceived lower value than a similar private company run by a team of experienced managers because customer loyalty to a single person is less dependable, as is concentration with one customer or a limited group of customers. Economic and market conditions will also impact the value of a business. For example, a business locked in a struggle for market share with strong competitors should not carry a premium price.

Deal structure

The biggest question for a buyer is whether to purchase a company’s stock (equity) or assets. Most deals in the closely held businesses space are asset deals. While the reasons are many, the two most important are the tax benefits that an asset deal provides the buyer and the limited liability that will come with the assets purchased.

Regardless of the type of entities involved, when the buyer purchases the assets of the selling business, the buyer gets to increase the value of the assets purchased to the value purchased at and depreciated under current generally accepted accounting principles and income tax regulations. In a stock deal, in most instances, there is no write-up of assets, and the buyer does not get to benefit from the investment made until the business is sold. (The investment is the basis which can be deducted when the investment is sold.) In addition, many business advisers are against the purchase of a business stock because the buyer could be liable for unknown liabilities incurred by the seller, which have now become the buyer’s problem.

Final thoughts

This article is only an overview of the financial considerations for the buyer and seller in an acquisition transaction. For example, another important factor in the sale of a propane company – or any business, for that matter – is the type of entity being sold, which has important implications on how much tax must be paid, by whom and when. This topic is complex enough for its own article. That’s why if you are considering buying another propane company or selling yours, it is important to get qualified M&A and tax professionals involved early.

Never lose sight of the fact that, in an acquisition transaction when one company is purchasing another, the buyer and seller have opposite objectives. The seller wants to maximize how much it gets for the business, while the buyer wants to minimize how much it pays. Whether you make the best deal possible depends on the work you and your advisory team put in up front.

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Marty Kirshner and Joe Ciccarello are partners in the Energy Practice Group at Gray, Gray & Gray LLP, a business consulting and accounting firm that serves the propane industry. They can be reached at 781-407-0300 or powerofmore@gggllp.com.