2012 Conference Preview: The Number One Mistake in the Sale of a Home Care Agency

By Donald Cummins, Stoneridge Partners

“I made my fortune by selling too soon and too cheap”. Take a moment to think about that. Those words were spoken by a Texas serial entrepreneur who helped finance the start-up of many companies, including a home care agency….which is how we met. His point being that the best time to sell is while revenue is on the way up.

Through years of experience I have to agree. I have found that, in considering a sale, one of the most important issues business owners face is timing. While the business is growing, owners want to hold off in order to receive top price. But if the business turns down, a great deal of value can be lost, and lost quite quickly. I have found that many owners underestimate the loss of value that results from a relatively small drop in revenue.

Here is a simple chart that shows the effect of a 10% drop in revenue. That doesn’t seem like much, however the end result may very well be a drop in the selling price of over 40%. This is not an exaggeration. Follow the logic.

Year 1 Year 2 Difference
Revenue 3,000,000 2,700,000 -300,000
Cost of Sales 1,890,000 1,700,000 -190,000
Gross Profit 1,110,000 (37%) 1,000,000 (37%) -110,000
G&A Expenses 660,000 690,000 +30,000
Adjusted EBITDA* 450,000 (15%) 310,000 (11.5%) -130,000
Multiple 4.2 3.5
Selling Price 1,890,000 1,085,000 -805,000 (-43%)

*Adjusted EBITDA(AEBITDA) = Net income before interest, federal income taxes, depreciation, and amortization, including all owner’s salary, payroll taxes & benefits, and any non‐recurring or unnecessary expenses, less non‐ recurring income, and a replacement salary for a working owner

The numbers for year one reflect what we might see in a well-run private duty agency: Gross profit of 37% and a bottom line EBITDA of 15%. This is a well-run agency with a history of moderate growth.

In order to arrive at the selling price we use a multiple of 4.2 times the adjusted EBITDA. This gets us to a selling price of $1.89 million, which is conservative.

In year two we see a moderate decrease in revenue of 10%. This can be easily accounted for by poor economic conditions, increased competition, death of high revenue clients, etc., all reasons that may be beyond the control of the owner.

Gross profit holds steady at 37%, but even so, this results in a loss of gross profit dollars of $110,000.

The expenses in year two drift up slightly, about 5%. This is common due to the lag time between the reality of a drop in revenue and the reaction of the owner. It takes time for reality to sink in. Meanwhile, the normal course of inflation takes its toll.

This results in a drop in the bottom line of $130,000. Still not too bad, but unfortunately this results in a double whammy because the business is no longer growing and no longer deserves the multiple of 4.2. A more likely multiple will be about 3.5, which, when multiplied by the lower EBITDA, results in a drop in selling price of $805,000 or 43%. Ouch!

Again, this is not an exaggeration, it is a situation that we see time and time again, and it is the number one mistake that we see owners make….waiting until things are going downhill before giving us a call.

According to a recent poll by the International Business Brokers Association, about 75% of a business owner’s net worth is tied up in their business, i.e. they have a lot of their eggs in one basket. It is important, therefore, to watch that basket very carefully and, if considering a sale, they might do well by pulling the trigger when things are going well.

It has been said that the outcome of a rain dance has a lot to do with timing (think about that). The same might be said for the sale of a home care agency.

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