Interviews

An Interview with M&A Source Member, William “Bill” Loftis

Tell us about your pre-M&A career and how it led you to doing this work?

Many, many moons ago when gas prices were beyond the reach of normal American citizens, inflation was in double digits, and another great Democrat governed the land (i.e., Jimmy Carter), I enrolled at Colorado State University in its Master of Science in Finance program. I thought the curriculum would position me to work in a variety of industries like investments or banking. The coursework was generally fun. I studied bank management, cost accounting, modern portfolio theory… but I was mostly intrigued by advanced courses in mergers and acquisitions and company values.

Fast forward a few years, I joined my dad in a startup title insurance agency. My dad was a remarkably smart attorney, and I was a cocky kid with a degree. Within a year, we had the opportunity to buy another title agency, so I pulled out my old graduate school notes to analyze the opportunity. We bought it. We paid far too much, but it became a nice springboard for growth.

Over the next 12 years, we grew the title agency to roughly 150 employees. My dad was 65, and ready to retire. He suggested we sell the business. I wanted to buy my dad’s stake, but like most sons, I didn’t have that kind of money. It would have been too risky for my dad to finance the transaction. In retrospect, I wish I knew about private equity firms and recaps back in 1994.

We determined to approach a single buyer, a publicly traded national title insurance underwriter (“Company A”). We took the following steps:

• Paid to have the business appraised.
• I assembled a marketing book on the company (my first CIM).
• My dad drafted a Confidentiality Agreement, and we approached Company A.
• The buyer eagerly signed the Confidentiality Agreement, and we shared the CIM.

I fell in love with the selling process. The buyer was sophisticated, gracious, flattering, and loved our agency. They offered one amount. We rejoined with a higher value. They agreed. We signed an LOI; went through due diligence; and prepared to close the deal.

I was extremely proud of our accomplishment… until the day before closing.

I had to notify our largest issuing underwriter (Company B), also a public company, that we were selling to Company A. I told the State Manager, “Today we are your biggest issuing agent in the State of Michigan. Tomorrow, we will be owned by your biggest competitor.”

In less than an hour, Company B’s CEO called imploring us not to sell to Company A. Without knowing the price or terms, he said he would double the offer!

My dad and I suddenly had a dilemma. Should we close with Company A on the original terms; renegotiate with Company A; suspend the process with Company A and begin anew with Company B?

This is when I discovered the meaning of the phrase “Pregnant with the Deal”. We closed with Company A at the originally negotiated price because: 1) the buyer’s board had already approved the sale and would not meet again for several weeks; 2) we felt honor bound; and 3) another due diligence process with a different buyer would have taken too long to complete with no assurance of a closing. Essentially, we settled for the bird in hand.

After the transaction, I had a nagging feeling that two really smart guys got schooled in the M&A process. Here are a few of the things we did wrong:

• Settled for too little – Because we did not run a competitive process, we never allowed the market to tell us what the value of our business was. Instead, we permitted an appraiser and a single buyer to determine price. We discovered another buyer with distinctly different strategic valuation views was willing to pay dramatically more. How much more might we have realized if we had only run a competitive process? We will never know for sure.
• Paid too much in taxes – We accepted an asset transaction structure rather than a stock deal. We learned later the buyer would have acquired the stock in our C-corporation without a price concession if we had only asked for it. Instead, we accepted the asset offer with no guidance from a tax expert. In the end, we paid taxes at the corporate level and then again at the personal level. Double taxation dramatically reduced the net value of the deal.
• We accepted wrong terms – The buyer offered to use a combination of cash and its common stock as currency in the deal. My dad wanted all cash. He reasoned, “I already have stock in a title business. Why would I want stock in another title business?” I offered several reasons like liquidity, opportunity for appreciation, dividends, deferred taxes in a like-kind exchange… It is interesting how risk tolerance diminishes as one ages. He wanted all cash – period. I would have preferred their stock together with a modest amount of cash. With an all-cash deal, we still had to find other places to invest the money.

As a side note, the price of Company A’s stock at the time of closing was $11 per share. It would have been restricted for two years. Exactly 24-months after our deal closed, Company A’s stock price on NASDAQ was $64 per share. We might have realized 6X more if had we believed in the buyer’s future.

Here is what I discovered from our transaction:

The mistakes were preventable – We were very good at running our business, but we were unfamiliar with how the private capital marketplace operated. If only had someone to guide us through the highly confidential and complicated process, we could have avoided minefields and achieved a much better outcome.

Mistakes are permanent and unrecoverable – Once the closing papers are signed, it’s like taking your hand off a chess piece – the move is made and there is no going back. Lost opportunities are gone forever.

Middle market M&A is a specialized area of knowledge – The stuff I learned in graduate school mostly applied to publicly traded companies. Private company transactions take place in the private capital marketplace, which is vastly different from public markets.

In the years following the sale of our title company, I worked with Company A in a variety of executive roles including searching for other title companies to acquire. I participated on pre- and post-closing teams to identify and ultimately capture synergies and assimilate cultures.

I left the title company and began receiving calls from owners of title agencies and real estate companies from around the country asking for selling guidance. I wrote reports at an hourly rate advising on things to do and things to avoid. I discovered I loved helping owners through selling process, so I decided to focus on middle market transactions as a new profession.

I quickly learned I knew more about M&A than many, but not much more. So, I immersed myself in industry education. I took courses from IBBA and M&A Source. I earned the CBI and M&AMI. I joined AM&AA to be sure I was getting a full-orbed perspective and earned the CM&AA. I became a Certified Valuation Analyst through NACVA. I got securities registered with the Series 7, 24, 66, 79, and 82. I read whatever I could find. I picked the brains of M&A lawyers at lunch and on the golf course. I became friends with PE professionals. The passion for M&A knowledge became an all-consuming unquenchable pursuit.

Another thing I did back then and still do today, is talk to owners who have gone through the selling process. I find their names in press releases and other places. Nearly all owners are willing to discuss their transactions if I don’t get too nosey about prices and terms. I mostly want to understand their experiences. Did the sale deliver what they hoped? What surprised them about the process? Looking back, did they have any regrets? The most often cited lament I have heard through the years is, “I wish I knew then what I know now about selling a business. I would have done things differently.”

My good friend Darrell Arne frequently asks, “What is the why behind what you do?” For me, I want to help owners achieve regret-free outcomes by providing actionable M&A knowledge before it’s too late. I want owners equipped with the foreknowledge necessary to make wise decisions on the most important transaction in their lifetimes.

What personal characteristics and strengths have supported your success in this industry?

Personal characteristics relate to all those internal qualities that make the person who he/she is. Three elements that have been important in my career are:

• Christian ethics – I don’t like talking about my personal faith to clients. I would rather they discover my belief system through my actions than my words. The package of Christian ethics includes honesty, trustworthiness, genuine concern for others, denying oneself, a word as a bond, hard work… When taken together and personalized, integrity is the result.Interestingly, I don’t like it when clients lead with their religiosity to establish ethical credibility with me. Every dispute I have ever had in this industry has been with self-professed devoutly religious client. I suppose everyone is righteous in their own eyes, but Christians with seared consciences are ugly to behold.
• Intellectual curiosity – I am continually fascinated by the many ways people make money. The vast array of NAICs codes reveal more kinds of businesses than one could ever imagine. What products and/or services does the company deliver? Who wants their products and/or services? How do they win customers? How do they make money? How do they manage employees? What story do the financial statements tell? Are the gozzintas (revenues) bigger than the gozzottas (expenses)? Our eagerness and willingness to understand everything about the business enables us to articulate the value proposition to a universe of awaiting buyers.
• Confidence – Private business owners rely on folks like us because we know what we are doing. When we can sound a clear and certain trumpet about the selling process, it encourages owners in times that can be very stressful. In addition, the more confident we are in our cause, the more effective we can be for clients.

Professional strengths, to me, are different than character qualities. Strengths are those aspects one can work on to become a more consummate professional. I’ll list three:

• Financial acumen – I know, I know… private companies are more than just financial assets to owners. Businesses are often interwoven into owners’ identities, so emotions are always involved. Some might even argue a curriculum in psychology is the more relevant training.In the end, however, business sales are financial transactions in essence. Owners may experience a host of conflicting emotions when selling; but those seem to resolve when money is finally wire transferred into their account at closing. Professional buyers are unencumbered by emotional baggage, and approach transactions purely from a rational financial perspective. Therefore, the intermediary needs to translate the business story into “Financialese”, so buyers can understand it.
• Private capital market awareness – Where do private companies go when they are taken to the “market”? Do they go to something like a real estate multi-listing service? Is there a place where buyers gather like the M&A Source PE Expo? Is that the market?In reality, the private capital marketplace is no place at all. It is entirely decentralized. The intermediary becomes the center or nexus of the market by identifying the universe of best buyers, and proactively approaching them with the opportunity. In other words, the intermediary is the market-making mechanism that enables buyers and sellers to negotiate and reach agreements. The more dealmakers understand how private capital markets operate, the better they can perform their market-making roles on behalf of clients.
• Broad-based M&A knowledge – Every deal has a variety of aspects – commercial, financial, legal, tax, environmental, emotional, psychological… The broader an intermediary understands each component of a deal, the better services he/she can deliver to clients. For example, it is important for intermediaries to recognize problems early in the transaction process, so they can be addressed and corrected quickly. Unattended problems never disappear. They simply become dealbreakers in the end.To illustrate, if an intermediary understands that certain representations, warranties, and indemnities will be problematic for a seller at closing (e.g., failure to file state taxes where revenues have been collected), he/she can bring the issue up to the whole deal team and begin searching for ways to rectify the problem. Perhaps an insurance policy is the right solution. If so, get the insurance provider involved early to provide a quote.

What is your greatest M&A accomplishment?

My most meaningful accomplishments are measured by the clients who become friends during the process and remain close thereafter. Every engagement requires weeks, months, and sometimes even years to finish. Communication occurs throughout the process, often daily. When you work closely with genuinely nice people, their concerns become your concerns. Their dreams become your dreams. Their families become your family. When these friendships endure long after my services have been delivered, I consider those as my greatest accomplishments.

I also take great pleasure whenever I participate in the process that assures business continuity beyond an owners’ involvement. There is a time in every entrepreneur’s journey when ownership needs to pass to others. For the good of all who depend on the business, new ownership must take the reins applying new visions for growth, new energy, new capital… I feel like I have done something honorable when my efforts enable all who are touched by the business to continue their financial lives without disruption through ownership changes. Something about it satisfies my soul.

With regard to the majority of your engagements, do you work as a team, or do you handle things on your own?

In the beginning, I did it all; but with a few successes and more reliable revenue streams, we hired more people to do research, assemble CIMs, and perform other specialized roles. Now, every service we provide is delivered through teams. Teams promote divisions of labor, accountability, iron-sharpening-iron synergies, and a host of other efficiencies.

I typically work on sell-side engagements as part of the team – usually as the Senior Banker (a.k.a., senior investment banker). Typical team members include a research associate, an analyst, and a junior banker, and the senior banker.

It is noteworthy that we migrated from an independent contractor model to a W-2 model, which was scary at first. When revenues are extremely variable, committing to fixed expenses (i.e., salaries, benefits, etc.) was a leap of faith. Fortunately, we trusted the right people. Our employees have stepped up their games so that our entire service package is exceptional.

Do you just do M&A or do you provide other services – valuations, consulting, etc.?

Blue River has three primary service areas: 1) a vigorous buy-side practice, 2) a strong sell-side practice, and 3) a valuation practice. Most of my activities fall in the sell-side and valuation divisions; although I support the buy-side as needed.

We started the buy-side practice in the early 2000s. It has taken years of continuous improvement, but our buy-side group is among the best in the nation according to clients who have used multiple buy-side firms. It has been years since we sought buy-side clients. They come to us.

Our valuation practice is different than many because we focus exclusively on valuations for transaction purposes. Some say valuations are more art than science, but they are really more advocacy than art. How else could two appraisers come up with wildly divergent values when representing different sides in a divorce? Or how do valuations consistently come in at the low end of the scale when presented to the IRS for tax purposes? Blue River’s only objective is to render an opinion on what bona fide buyers, often specific buyers, are likely to pay for the business.

Blue River’s valuation models utilize all the traditional approaches and methods applied by other appraisers, but we incorporate more rigorous analysis. For example, we include perspectives from capital providers, i.e., buyers and lenders. We measure the viability of deals based on a variety factors like cash flow forecasts, deal structures, debt service coverage ratios, collateralized borrowing capacity, buyer hurdle rates, and more. We identify, justify, and quantify potential synergies related to specific buyers. In the end, we provide business owners with an extremely realistic view of what is achievable in the marketplace. Sometimes owners like what we say, sometimes they don’t; but far be it from us to provide unrealistic guidance. Some owners update our valuations annually to measure if internal strategies are delivering wealth enhancing results.

I am reluctant to brag about our sell-side practice, but I am reminded of the great quote from Mohammad Ali, “It ain’t bragging if you can do it.”

What is the biggest mistake you have made when working on a deal?

There have been plenty of occasions where I perceived market realities differently than actual buyers in given industries. I have missed things in financial statements that I should have caught like accumulating management bonuses that should have been reflected as liabilities. My first few experiences with project-accounting issues were hard lessons, i.e., how much cash does the seller need to leave in the business for projects in process?

All the above were embarrassing, but the mistake that haunts me to this day was related to a nice business valued in the $30 million range. Everything about the company was exceptional. However, I found it peculiar that management didn’t produce or use financial forecasts. The company was debt-free, so there was no externally imposed requirement for budgeting. If revenues went up or down year-over-year, the owner’s attitude was, “Don’t worry, be happy.”

When preparing the CIM, I argued we should include a financial forecast. I suggested buyers want to understand where the business is going. Who better to guide their thinking about the future than us? We knew the business far better than any outsider.

The owner ultimately relented to my brilliant argument. He said I could include a forecast in the CIM if I thought it would help. I prepared the forecast, and the owner approved it for the CIM. However, there was no true buy-in from the owner or management. There was no commitment deliver against the budget.

Fast forward to a signed LOI and two months into the due diligence phase. The highly qualified was tracking year-to-date performance on a month-to-month basis. The buyer called me to say actual financial statements were not tracking with the forecast. The buyer argued the offered purchase price was tied to the forecast, but since it proved to be a mirage, the price needed to be reset. The seller wouldn’t budge.

Ultimately the deal failed over my “expert opinion” that forecasts were required in the CIM. I learned that the business and its ways are what I am trying to represent to buyers, not what I think the business should be doing. Whenever I impose outside elements on a business that don’t exist in practice, the consequences are never good. In this case, I was the creator of an unnecessary insurmountable problem.

What are the three most important qualities that you think a good M&A advisor needs to have?

It is impossible to do this job at a professional level without M&A knowledge. Therefore, I rate education/experience/knowledge as the most important attribute for folks in our industry.

Secondly, M&A advisors need to be honorable. We need to have a keen sense of fair dealing with all parties involved. The best transactions are those that endure the test of time. The deal must be good and fair at the time of closing and long afterwards. As hard as it may seem for starving M&A advisors, our success fees should be the least of all considerations for the deal. If it is in the client’s interest to walk away from a bad transaction, that should be our heartfelt position too. We need to do what is right, and rewards will come as a result of that commitment.

Thirdly, we need to be calm, patient, confident problem solvers. I have never seen a transaction that didn’t have challenges getting to the closing table. I think Jesus must have been a dealmaker at heart because he promised, “…In this world you will have trouble…” (John 16:33) We should expect trouble on every transaction.

I suspect Solomon was a dealmaker too, because he said, “The end of a matter is better than it’s beginning,” (Ecclesiastes 7:8a) which is exactly how I feel about closings.

What is your most interesting deal that you are working on today?

The question is like asking a parent, “who is your favorite child?” All our deals and clients are special.

However, we are delving into new waters representing major multi-billion-dollar corporations carve out and divest orphan divisions. It is fascinating because it is like surgically separating Siamese Twins. Is it possible for the carve-out to survive on its own, or must it be coupled with another strategic buyer? If the carve-out is to stand on its own, how will shared functions be managed after the sale like accounting, human resources, IT, and others. The process of creating specific income statements and balance sheets for the unit sans corporate overhead allocations is challenging. It is also fun to hear how top financial minds from major companies view the selling process. It’s pure finance, baby – no emotions whatsoever.

How long have you been an M&A Source member and what do you get out of your membership?

I think I joined IBBA and M&A Source in about 2003.

The full answer what I get out of my membership would require another 30 pages, so let me summarize in order of priority.

• Friendships – M&A Source has been the forum that fueled some of my most precious personal and professional friendships. Most of my M&A mentors came from M&A Source. Men and women from the private equity industry have taken me under their wings. I doubt there many organizations on the planet that have more giving and gracious members than M&A Source.
• Education – The recurring theme throughout this Q&A response relates to knowledge. Much of what I learned came from M&A Source. Over the course of time, M&A Source has provided some of the best courses, best educators, and best learning settings. The foundations of my practice are built squarely on education provided by M&A Source.
• Benefits – M&A advisors need tools to conduct business. M&A Source has worked diligently with key service providers to assure its members can access important resources free of charge or at steeply discounted prices. Unless money is no object, these benefits provide enormous value to members.
• Opportunity to give back – M&A Source has been gracious to allow me to express my gratitude by serving in different roles. For example, I have been asked to write and teach courses over time. That has been a blast. Few things please me more than passing knowledge along to new generations of M&A professionals.

As a seasoned M&A advisor, what changes and trends do you see on the horizon that will impact on M&A?

There are lots of cool things out there for folks in our industry – specialized CRMs, industry research, company databases, outsourced dealmaking services, valuation and dealmaking software… All those tools can help make us become more efficient. I don’t see any game changing products, services, or technologies on the horizon that will fundamentally threaten to make our services obsolete. Artificial intelligence has a way to go before it can replace any of us.

Economic cycles should pose a more immediate concern for folks in our industry. We have enjoyed a strong wave of activity over the last few years – even through the pandemic. Private company values have been trading at multiples beyond belief in some sectors. Even so, I counted no less than 5 articles in this morning’s Wall Street Journal that discussed a potential recession. It appears, economic activity may be heading for even sharper declines than many expected. For example, if truckers can’t afford to fill up with gas and they must park their vehicles, how will can that positively influence existing supply chain challenges?

So, we need to ask how will recessionary headwinds hurt or help our industry? I have some thoughts…

• Private company values are heading down – fast! Inflation, supply chains, war, politics… they all add to uncertainty, and uncertainty is another word for risk. As risks rise, prices go down.
• Private company EBITDA multiple are likely to decline by 1 to 3 turns in the next 2 years. Recession is no longer a silly notion; it is the most likely reality. Private company values have been at historic highs for a couple of years, so a significant downward adjustment should be expected.
• Sell now! For owners with any inclination to sell, it would be better to sell today than tomorrow; better to sell this month than next month; better to sell this year than next year; better to sell sooner than later… Why? Business values are declining from historical highs at the same time inflation is going up. That is a double-barreled blast with against owners’ real net worth.

If you want mathematical proof that values have fallen since the beginning of 2022, consider that all buyers, lenders, appraisers, and other capital providers rely on Discounted Value of Future Cash Flows (a.k.a., “DCF”) to determine the value. EBITDA and multiples are only proxies for how bona fide buyers arrive at price.

DCF has two primary components: 1) the risk adjusted discount rate, and 2) forecasted cash flows. The formula produces the present value of future benefit streams, which we fondly refer to as enterprise value. Whenever risk adjusted discount rates go higher and earnings forecasts go down, enterprise values decline.

Consider what has happened in the private capital marketplace in just the last couple of months:

• Risk Adjusted Interest Rates are Higher – Kroll (formerly known as Duff & Phelps Cost of Capital Navigator) is a service that recommends appropriate risk adjusted discount rates to use in specific industries. The so-called “Buildup” method takes the risk-free rate (i.e., the 20-year Treasury Note) and adds other risk premiums unique to industries, company size, and other factors to arrive at the discount rate.
• To illustrate, on a valuation performed in the first quarter of 2022, we used the following risk adjusted discount rate:
  • 20-year Treasury Note (risk-free rate) 2.0%
  • Equity risk premium 9.0%
  • Unique company risks 5.0%
  • Total Risk Adjusted Discount (Buildup Method)  16.0%

The inverse of a Risk Adjusted Discount Rate is approximately the multiple of EBITDA with some modest adjustments. Here, the inverse of 16% is 6.25. So, the EBITDA multiple interpolated from the cost of capital is roughly 6.25X.

The Fed has been raising the Federal Funds rates, and all other interest rates are increasing too. The 20-year Treasury Note was at 3.77% on September 19, 2022. We expect it to continue rising until the Fed tames inflation. In addition, pervading economic uncertainty has added other risk elements that didn’t exist at the beginning of the year. If we ran the numbers on the same company today, with the higher risk-free rate and additional risk factors, the discount rate would be higher as shown below.

• 20-year Treasury Note (risk-free rate) 3.77%
• Equity 9.0%
• Unique company 5.0%
• New economic risks 2.5%
• Total Risk Adjusted Discount (Buildup Method) 20.27%

The adjusted discount rate increased by four hundred twenty-seven basis points in since the first quarter due to inflation and the risk of recession. The inverse of 20.27% produces an EBITDA multiple of approximately 4.93X. In other words, the EBITDA multiple declined by 21.22% from the beginning of the year. Those are forces business owners have no control over.

But that’s not all…

• Cash Flow Forecasts are Declining – Economic headwinds will adversely affect future business performance across many industry sectors.Assume the company we appraised earlier this year forecasted 2022 EBITDA at $2 million. If we re-ran the numbers today considering today’s economic realities, the forecast might be $1.8 million.In the first quarter, the value of the business would have been 6.25 X $2 million = $12.5 million.

  Now, with a revised EBITDA forecast and a reduced multiple, the value is $8.87 million ($1.8 million X 4.93). That is a 29% decline in value in only six months! The math shows private company values are falling before our eyes!

For sellers thinking about selling, “NOW” is the watchword of the wise!

What advice would you give to new people entering the profession?

Make friends quickly. Get knowledge. Apply what you know.

This is not a business where you can fake it until you make it, because the consequences of bad representation are too high for transaction principals. If you are new and uncertain about how best to represent sellers, partner with an industry veteran to learn how. That person can be at an entirely different firm.

For example, if you have an opportunity to represent an automobile dealership in a sale, don’t wing it. Find someone with expertise in M&A Source to run the deal together. Make it easy for the co-advisor. You be the gopher. You carry the weight. But, by all means, make sure that client has excellent representation.

Please tell us something about yourself that has nothing to do with your M&A career?

I don’t like pinacolatos, and walks in the rain, but I do love golf and most other sports. I am married to a remarkable woman who is a constant reminder that I am a fortunate man.

Before my race is finally run, I really hope to complete a book on the M&A process. The busyness of the work makes it hard to devote much time to writing, but I am committed to getting it done. I don’t have delusions of commercial success or appearances on CNBC; but I hope it will be useful to business owners and their advisors before they embark on their M&A journey.

 

William “Bill” Loftis is Managing Partner and co-founder of Blue River. Mr. Loftis has assisted buy and sell-side clients through the M&A process in multiple industries, such as, financial services, military equipment, forestry, automotive, mining, specialty chemicals, steel, surgical equipment, business services, construction, real estate, title insurance, pharmaceutical clinical trials, food distribution and others.

Mr. Loftis developed a passion for M&A as a transaction principal. He co-founded one of Michigan’s largest title insurance agencies, which was subsequently sold to LandAmerica Financial Group, a Fortune 500 insurance underwriter. He participated in M&A evaluations and national assimilation projects at the highest levels for LandAmerica (now part of Fidelity National).

Mr. Loftis earned a B.A. in Business Administration from Alma College and a Master of Science in Finance from Colorado State University. Professional accreditation’s include the Certified Business Intermediary (CBI) and Merger & Acquisition Master Intermediary (M&AMI) designations from M&A Source. Through the Alliance of Mergers and Acquisition Advisors (AM&AA), Mr. Loftis holds the Certified Merger and Acquisition Advisor (CM&AA) credential. He is a Certified Valuation Analyst (CVA) through the National Association of Certified Valuation Analysts. He is an active member of the Alliance of Mergers and Acquisition Advisors, M&A Source, Association of Corporate Growth (ACG), National Association of Certified Valuation Analysts (NACVA) and other professional organizations.

Mr. Loftis is a former board member of the International Business Brokers Association and M&A Source, the nation’s largest association of middle market deal making intermediaries. He is a regular speaker/instructor at national conferences addressing M&A and valuation topics. He has authored and co-authored multiple advanced educational courses used in the accreditation process for industry professionals. For his contributions, he has been recognized as a lifetime Fellow of M&A Source, the highest honor awarded by the association.