Brooks CowlesWe believe the merger and acquisitions market for funeral homes and cemeteries is characterized by good fundamentals at the time of this writing (January 2008), but with an uncertain future. Some currently favorable fundamentals are a wide range of buyers (first-time buyers, established independents, regional and national consolidators), good financing choices (conventional banks, SBA, industry lenders), low borrowing rates, and favorable tax rates for sellers. Several of these fundamentals, however, could change dramatically before the end of 2008.

It is unclear what effect the unraveling credit markets will have on borrowing by business buyers. Housing market problems may begin to leak over to commercial real estate markets, and have in some areas. Equally unclear is the future for historically low capital gains tax rates in this election year. Finally, the looming effect of cremation rates and timing of expected demographic changes add to an uncertain future for transfers of funeral homes and cemeteries.

For an owner considering whether this is the time to sell, or how to protect or enhance his value for a future sale, what can be done while waiting to see how the fundamentals unfold? The answer is Value Drivers.

When offering a business for sale, Value Drivers are matters within the owner’s control that have the greatest impact on achieving premium value. To be sure, in addition to the above fundamentals, there are many other factors that influence value, including reputation, area demographics, competition, facilities, etc. These factors are partly in the owner’s control, but also subject to factors that the owner cannot control. Value Drivers are those matters that the owner can address at any time he chooses, good market or bad, that will always have a positive impact on business value. What are some Value Drivers in today’s M & A market for funeral homes and cemeteries?

Effective Financial Controls. Financial controls are documented in financial statements and reports. To be an effective Value Driver, these documented financial controls need to be accurate, timely and detailed. Properly done, these controls are a critical management tool. More importantly, effectively documented financial controls help verify for a buyer (and their lender) the financial condition of the seller’s company.

Consider the seller who is currently having an above average year, while marketing his company for sale. Try telling a buyer that even though it has been 8 months since the tax return, calls are up and dollars should be too. Is it any surprise the buyer’s response is

“prove it?” Much better is the seller who can show not only monthly statements of income and expense right up to the current date, but even document particular areas where volume and averages are up.

Not only does this seller make an effective case for higher proforma cash flow, but the attention to detail and controls creates a favorable impression of the entire business that often translates into a premium price.

Management Team. Having a solid management team in place is another Value Driver for an owner planning a transfer. Though this may seem obvious, an owner needs to have some understanding of his likely buyer to know what is appropriate. A fairly paid, effective manager is essential if the buyer already owns one or more other businesses and needs someone in place. For a buyer who plans to move in and operate the business himself, however, that manager and his salary may become an unnecessary expense. Releasing the manager may be an unwelcome prospect for both buyer and seller, especially if there is not a noncompete agreement in place.

An unsettled management team almost always results in lower offers, fewer prospective buyers or both. Advance consideration of the market for a particular firm is important to establish an appropriate management team as a Value Driver.

Management Systems. Suppose you feel that you have a great team in place, ready to hit the ground running and help a new owner be as profitable as expected. How do you know, and how do you prove it to the buyer? Detailed, timely management reports that accurately measure performance and allow rapid responses are a tremendous Value Driver. Beyond the financial controls mentioned above, these reports might include:

  • sales average reports for revenue categories by company, location and arranger;
  • business mix reports tracking percentage of cremation, burial, forwarding, receiving and preneed fulfillments;
  • customer satisfaction surveys and reports; and
  • accounts receivable aging reports.

As with financial controls, not only does this seller make an effective case for higher proforma cash flow, but the attention to detail and controls creates a favorable impression of the entire business that often translates into a premium price.

Begin with the End. The legal, tax and ownership structure of a business can be another Value Driver. A structure that allows for an asset sale, with or without real estate, and free of any issues with dissenting partners or shareholders is worth a lot to a prospective buyer. Unfortunately, many decisions are made by owners at the establishment of a business and later without any consideration of the impact at the time of sale. Consider a few actual situations we have recently encountered:

  1. Owner owns cemetery and funeral home in the same subchapter – C corporation.
    1. The C-corporation means that on a sale of assets, the owner may be taxed twice on the same gain. The alternative is to force the buyer to buy stock, which has liability and tax implications for the buyer.
    2. By owning the funeral home and cemetery in the same C-corporation and pushing a stock sale, the seller loses the ability to look for the best buyer for each business. Only a buyer willing to buy both businesses in a stock purchase can be considered.
  2. Owner owns highly-appreciated vacation property in the same C-corporation that owns business.
    1. Instead of paying tax on $150,000 gain from an earlier real estate sale, the owner re-invested the proceeds in property now worth $1 Million.
    2. Again, C-corporation means owner needs to sell stock, but that means vacation property would go to buyer. To get property out of corporation prior to sale, owner may have to pay tax on gain of nearly $1 Million just to keep property.
  3. Upon presentation of Letter of Intent, owner had to disclose that a distant relative by marriage had a longstanding, unresolved claim to a small percentage of the company. There was no buy-sell or other arrangement in place.
    1. Even if buyer was willing to buy less than 100%, most lenders would not finance the purchase without a security interest and mortgage in clear title.

All of these situations arose out of the owner’s being unaware of the future impact, or making a decision to save a few bucks now and “deal with it later.” Even where there is an unfavorable ownership structure, addressing the problem before embarking on the sale process may turn a negative structure into a Value Driver.

Start Now. The common denominator for all of these Value Drivers is that they require some degree of advance planning. In addition, they are all matters that should benefit an owner throughout his ownership, in addition to bringing increased sale value. To implement processes and systems that offer current benefits as well as increased sale value, consider working with a firm that has experience and expertise in both.

We understand that not every business is suitable for each of these systems, but especially in an uncertain market, it is more important than ever for an owner to focus on these and other Value Drivers to position himself for a premium price. If financing, tax rates and other fundamental remain favorable, the owner will achieve a premium price, in addition to the benefit of a good market. If fundamentals turn downward, the owner who needs to sell can still receive a premium by being a premier offering in a tight market.

This article does not constitute tax advice and no action should be taken based on the information provided without consulting a qualified tax advisor.

D. Brooks Cowles, Jr., Esq

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