A case study in guiding a family-owned business through a change of ownership.
With the baby boomers reaching retirement age, a large number of companies will change hands in the coming years. Many of these entrepreneurs will sell to family members, which is precisely the situation this business owner found himself in.
Pacific Restaurant Supply is a full service dealer of high-quality commercial food equipment based in Vancouver, British Columbia. The founder, now in his mid-50s, had transitioned management of the business, as well as 50 per cent ownership, to his son, Luke Evanow.
In 2012, it was time for Luke, who had been involved with the company for eight years and had independently managed all aspects of operations for more than two years, to buy out his father and assume full control of the business.
- The relationship between father and son had the potential to become strained and both partners wanted to preserve and protect family relations.
- As a service business, Pacific Restaurant Supply had only working capital assets available to pledge as collateral on conventional bank loans.
- Because businesses generally trade on a multiple of earnings, the value of this business exceeded the book value of its assets, resulting in goodwill. As an intangible asset, goodwill is notoriously difficult to finance.
- Luke, because of his relative youth, had limited net worth.
Pacific Restaurant Supply’s assets include accounts receivable, inventory, leasehold improvements and intangible assets. The company has limited property, plant and equipment and operates out of leased premises.
At the time, the company had no debt other than vehicle leases and a small, unutilized line of credit that was secured by a first charge over the company’s assets as well as the founder’s full liability personal guarantee.
Revenue, Gross Margins and EBITDA
With the exception of a 10 per cent drop in sales during fiscal 2010, revenues had been consistent for the past several years. The son believed the company had attractive growth prospects but was not incented to grow the business under a shared ownership model. Gross margins had been remarkably constant. Earnings before interest, taxes, depreciation and amortization had ranged from 6-10 per cent every year.
Debt Service Obligations
The only debt facilities that Pacific Restaurant Supply was responsible for servicing at that time were interest on its line of credit and the vehicle leases, leaving plenty of cash flow available to service new debt.
The solution—the experts weigh in
The family had been planning for succession for a number of years. In 2010, the company’s accountant (Dave Diebolt, CA, Manning Elliott) and lawyer (Scott Murtha, Boughton Law Corp.) reorganized its ownership in order to freeze the value of its common shares. Through this, Luke became a 50 per cent shareholder of the business and the value of the business was crystallized.
When it became clear that the buyout for the company was imminent, the partners turned to these long-time advisors for a solution.
- Bank debt – Based on the experts’ advice, the son changed banks, replacing the smaller line of credit secured by his father’s guarantee with a larger one margined at 75 per cent of current accounts receivable and 50 per cent of equipment inventory. The new operating lender also allowed a portion of the line of credit to be drawn down to fund the partner buy-out.
- Because the founder had already transitioned a 50 per cent interest in the business to his son, and because time was of the essence, the experts advised against asking the father to carry any of the financing, even though vendor take-back financing is a relatively common tool in shareholder buy-out situations.
- To make up the difference, Dave Diebolt suggested that the son consider subordinated debt financing. ‘Sub debt’ focuses on cash flow rather than collateral and is often used to finance goodwill. In this case, the sub debt was provided by First West Capital.
Under motivated and invigorated management, Pacific Restaurant Supply enjoyed banner results and has grown steadily ever since. Luke, who became the sole owner of the business following the buyout, later extended minority interests to key members of his management team. Today, Pacific Restaurant Supply has fully retired its sub debt facility with First West Capital, owns both its East Vancouver warehouse and its manufacturing facility in Port Coquitlam, and changed operating lenders to accommodate its rapid growth. The company has attracted the interest of strategic buyers at significant multiples. Luke’s tremendous achievements were acknowledged in 2014 when he was awarded Business in Vancouver’s prestigious Top 40 Under 40 Award. Luke, who recently assumed the role of Chairman, continues to lead vision and strategy for the company. A budding serial entrepreneur, Luke has now turned his attention to his next business venture, Glory Juice Co. We at First West Capital wish him every success in the new venture.
Learn more about how First West Capital can help you with a management buyout.