October 26, 2021
Capital expenditures (CapEx) are a part of every business’s story. Even so, a few business owners that we’ve worked with didn’t pay close enough attention to how these expenses were booked which made navigating the sale process harder than it had to be. For instance, when responding to buyer inquiries about their CapEx history and projections, they didn’t realize why the business CapEx profile was so important for buyers to understand, forecast, and model. Having witnessed this firsthand on more than one occasion, let me review why buyers are so adamant about modeling CapEx and how sellers might think about these expenses when they start planning a sale of their business.
Many buyers distinguish themselves by only investing in low CapEx-intensive businesses. As I shared in my previous blog, Preparing Yourself and Your Business for Sale, some buyers shy away from businesses that are overly dependent on a continuous infusion of CapEx to fuel growth. Conversely, others seek out heavily CapEx-driven businesses as this profile fits their operating philosophy or cash-deployment strategy. It’s important to know where your business lies on this continuum.
As you know, capital expenditures are the investments a company makes to either grow or maintain business. If an investment - such as a new piece of equipment - will have a useful life greater than one year and its original cost exceeds a predetermined threshold, then the expense is typically “capitalized” over a depreciation period rather than “expensed” as an operating cost incurred in the period it was purchased.
Buyers of businesses need to know what the historical maintenance and investment costs have been so they can predict future maintenance and investment costs based on answers to the following.:
1. Will they continue to operate the business as in the past – with the expectation they’ll achieve the same results?
2. Can they meet business operational needs and keep pace with growth the company is experiencing or forecasting?
3. Should they accelerate or maximize the growth potential of the business – through organic and/or acquired means?
Buyers need to model working capital, dividend expectations, and other treasury management and cash flow functions to determine if they have adequate investment capital and credit available to execute their plans. Factoring tax consequences, cash utilization, and whether investments earmarked for CapEx might be better utilized in other areas are hallmarks of financial engineering that many investors pay close attention to when determining whether they want to purchase a business. Additionally, financial buyers usually prefer the seller to make the investment in the business before a sale so the execution risk is already in play. Lenders, suppliers, customers, and QC inspectors all see a seller’s decisions in a different light than they’ll view decisions made by a new owner. Therefore, it’s often prudent for a seller to continue to make CapEx investments all the way up to just before a sale.
Problems sometimes arise because many sellers no longer have the risk appetite to make large purchases leading up to an exit, but if you need to invest in the business to sustain growth, maintain reliability, or ensure margins, you should do it. If you find yourself within a few years of selling your business and you’re wondering if you should change your strategy regarding investment in the business, wisdom says “operate the business as if it isn’t going to sell.” I can’t stress this point enough!
What a big CapEx investment means to a buyer before the sale of your business:
a. The buyer won’t have to make it – that’s a positive.
b. The buyer’s purchase price will include the asset, and it will be financed as part of the sale.
c. The required operational learning curve and process enhancements will already be in play.
The right buyer will understand the intangible value a seller has created for them by undertaking the expense and integration before handing over control. Therefore, you should confidently operate under the assumption that “if the business needs the investment, you should make it.”
In my experience, making well thought out CapEx investments leading up to a sale sends the message that your business is ready to transition, ready to perform for the new owner, and owned by a wise operator from whom the new owner can learn much.