Carl Allen and his team break down the intricacies of spotting financial red flags before purchasing a business, with a focus on a unique opportunity in the construction and subcontracting space. The featured business, an Arizona-based commercial glazing and fabrication company, has been in operation since 2010. Despite its longevity, the business is at a crucial juncture, with the majority owner looking to exit, while the general manager—who holds a significant portion of equity—remains actively involved in the operations.

Carl and his guests dive deep into the financials and operational risks associated with the business, offering valuable insights into key indicators of financial health. The company specializes in aluminum framing fabrication and glass installation, primarily working with commercial general contractors on high-value projects like hospitals, office parks, and car dealerships. The team discusses the business’s strong customer relationships and its steady stream of work from repeat clients, as well as the risks posed by customer concentration, with one client representing 49% of its revenue.

The episode highlights the challenges in construction-related businesses, from supply chain delays and inflationary pressures to labor shortages. These issues make it critical for prospective buyers to scrutinize customer concentration, the stability of client relationships, and working capital. Carl and the presenters focus on how to assess a business’s resilience by considering macroeconomic factors, cash flow cycles, and the dependability of long-term contracts. The company’s current backlog of work and projected growth potential are encouraging, but there are risks tied to the heavy reliance on one major client and the high turnover rate in field labor.

One major takeaway from this episode is the importance of a thorough due diligence process, particularly when it comes to assessing financial statements. The team discusses how the business’s balance sheet could be skewed by delayed receivables and a relatively low working capital cushion. They emphasize the need for a solid understanding of the cash conversion cycle and the potential impact of losing a key client. The team also discusses how to structure deals in such a scenario, including the use of seller financing and equity rollovers to mitigate risk.

Carl also highlights strategies for growing a business with these types of challenges. With a focus on the long-term potential for geographic expansion, industry roll-ups, and the development of a sales team, Carl and the guests suggest that while the business presents certain risks, its established customer relationships and backlog of work could make it a strong investment if the right steps are taken to diversify and stabilize its client base.

This episode is a must-listen for anyone considering entering the construction or subcontractor space, offering expert advice on evaluating risk, structuring deals, and spotting the financial red flags that can make or break an acquisition.

Full Transcript:

Okay. So, this is my husband, Stan, and I’m Folly, and then we’ll be, presenting on a commercial glass installed glazing and fabrication and conch subcontractor.

So, this business is in Arizona, and its history, comes from so it was founded in twenty ten. There were originally four shareholders.

Two of them have retired, one last in twenty twenty two, and another is looking to completely exit. The first owner owns sixty four percent of the business, and their role is more accounting, standpoint. But that role has actually been absolved in the company, so that owner is quite passive now. Owner number two is twenty three point five percent owner, and he is the general manager currently. He does more business development, oversees day to day operations, client relationships, and does some estimate work.

Our service here is aluminum framing fabrication. They do not fabricate glass. They only install the glass, but they do fabricate the aluminum. They install sliding doors, handrails, shelving. They have twelve staff on their team, five in leadership and two admin.

And then they have five installers and a glazier and glaziers.

So they’ve got a pretty well developed team and a mixed tenured staff. So they’ve got some people who have been with them for a good amount of time, and then they’ve also have, peep, some installers in Glaziers that came in about two to three years ago, who are younger because the job is a lot more labor intensive, needing them on the field.

So they serve usually commercial general contractors and specializing in hospitals, schools, office parks, car, dealerships, colleges, and more. They do new constructions and or remodels.

And they usually focus on their they have main clients that they focus on, big gen GCs, about fifteen clients.

Another thing to note here is three of the sons of the owner are currently in the business as well. So they it’s an additional layer that’s added to the staff.

So, who’s the team?

So we’re a husband and wife team. My name is Stan. This is Folly, as she mentioned.

And, what do we bring? We bring over, ten years of real estate in investor experience as well as successfully, managing, West Properties, renovations, structuring, working with, GCs and contractors, of of that sort. We also have a good total of fifteen years of health care experience, specifically, myself and managing teams, the, diverse group of teams, developing workflow systems.

And the main thing, with that is just basically enhancing collective, patient outcomes or outcomes based on the hospital in general.

We also have one of the current owners who was willing to retain ten percent of, rollover equity, who will retain in the business. He brings over thirty five years of experience in the actual business.

He has previously sold two other successful business businesses prior to his venture now.

He has a profound understanding of the owner investor model, having built these businesses, allowing him to operate independently.

I believe he works about twenty five to thirty hours in the business currently, ensuring that he’ll sustain growth and development in the company.

We’re also seeking or in pursuit of an angel investor, someone, with assistance for down payment.

We’ll talk more about that later. But someone also who has experience in the sector who can assist with development and growth.

So compound annual growth rate in this sector.

The CAGR is about point nine percent over the past five years. The total revenue of twenty point seven billion in twenty twenty three alone, expected to expand, the one point four percent to twenty two point two billion by twenty twenty eight.

So what are the industry challenges?

One of the main industry challenges dealing with, really any contract or subcontract, business is finding skilled senior labor on the field.

Supply chain, can delay job progress as well as, increase material costs during inflation or inflationary times.

There could be economic downturn that could slow down commercial construction. And lastly, labor intensive. It it is very labor intensive, so that can cause a high turnover rate during the field step.

Some unique selling points of this business. One thing we really like about it is just they’ve really dialed in on the mid tier job size. So their average job size is around six hundred k to seven hundred k.

And they take of a highest in the year, they’ll probably do around two million.

And with that size, they are looking at usually about twenty jobs and twenty twenty projects per year. So how they currently evaluate that is they’ll, you know, get bigger jobs to anchor down their year, and then they’ll pick smaller jobs to fill in the gaps.

And so because of this niche size, they’re able to be one of the best pricing and quality in their market. And this causes GCs to consistently come back to them for work. And as we mentioned, so their their customer concentration here is actually high because they have a huge national general contractor that’s been has a long tenure with them, that’s been working with them since twenty eleven, and they have forty nine percent of their twenty twenty three revenue. And they have a long history of having worked with this general contractor.

So as far as our customers, national GCs in this region, local and regional GCs. They do a ninety five percent of their clients.

Existing clients send them invitation for bids, and then eighty five percent of the projects that they have are from repeat customers.

So, new GC clients, which is really great about this business, are, referred by they’re manufacture manufacturers usually. So there’s no sales team. There’s no marketing, at all in this business.

As far as customer relationships, especially when you’re thinking about, a a high customer concentration, you’re thinking who who here really has the relationships in this business? Is it the owners? What happens when they exit? And the good thing about this business is no one person truly owns those relationships.

So the process goes like this. So bid invitation invitations are submitted to the company, and then the estimator will then submit the proposal. And from the proposal, if it is accepted, then the project manager will usually coordinate production and logistics with the GCs. And it’s a really and it’s a really multifaceted relationship, where different people on the team have been able to form relationships with these repeat customer clientele.

And especially with the national GC, it it’s not, you know, it’s not they’re not having those big relationships with corporate, but just the people on the field who are who are coming back to them to work with them.

Looking ahead. So what is the potential for growth? I’m speaking with the owner. There’s a four point three million backlog of work, for for this year alone.

Revenue for for twenty twenty three is four point seven million.

There’s five hundred thousand of of new revenue and twenty percent growth margins for twenty twenty four alone.

There is an opportunity to expand in the residential sector. Their primary focus is the commercial sector in this stage.

There’s also and there’s also opportunity to ex expand geographically.

The potential to hire more skilled work, as I mentioned, there’s a four point three backlog. So, more skilled, improper, work will allow them to be able to take on more jobs.

So this company is in Arizona, which is a a growing population specifically, twenty twenty two, seven point three million, and a plan to be eight million by twenty twenty eight. So definitely a growing, population in that sector.

So we believe that this is of of a fragmented niche. So that allows opportunities for roll ups, in that nature.

As probably mentioned, there’s no current sales team.

So they rely heavily on their their reputation and word-of-mouth.

So developing skill and proper, sales team can allow the opportunity to grow the the company further.

And and, yeah, there’s there’s a abundant amount of work.

So it’s more of a concern of finding the skilled labor as opposed to, finding work. So we think that there’s plenty of opportunity there.

Yeah. As we’ve mentioned previously, in this deal, we’re really looking for, we are looking for, partners as just, like, knowledge partners to help with the strategic growth, but also, you know, someone of an angel investor, that type who can come and bring in some industry expertise. We’ve partnered with the owner already who we’ve been able, just from talking with him, bounce some ideas of what growth can look like in the future. So we’re really comfortable in that relationship.

But the part is if a partner was to bring five percent or ten percent down depending on what was required by the SBA, these are some of the numbers and returns that you can expect. And and just to say that these are very conservative numbers just with our projections, we wanted to make sure that, you know, we had very realistic, conservative, and honestly beatable numbers, to show us a pot a potential for what the returns on on investment will be.

And from that, we will go to the financials.

Hold on one second, guys. I’m trying to pull this up here.

Okay.

So can you guys see this?

Just making sure.

Yes. We can.

Okay. So on the one sheet, so we’ve got their revenue here at around four million, four point seven in twenty twenty three.

Now they are asking for three point four five million.

They do have what’s included in that is a four point three million dollar backlog.

Working capital amount, they are wanting to only keep five hundred and twenty five thousand in the business.

And then the terms that they’ve offered and some of the terms that we’ve talked through with the owner is seller financing at ten percent, five percent interest five years, but we extended it out to ten years just with SBA regulations.

And then one owner is willing from just our conversation and talking with them. One owner is willing to roll ten percent of their equity and stay on as a two to three year, general manager and kinda continue in that role.

So the revenue is four point seven million in twenty twenty three. Now if you’re looking at this, you’ll see that there was a dip in twenty twenty two. And when we asked them about this further, he mentioned that, you know, some of the issues were supply chain, like we mentioned, some of the the threats and challenges in the industry supply chain in twenty twenty two. They also had not yet, factored in inflationary costs. And then there were some delays in their work that really that dropped them. But he says since that time that they have fixed those things to really make sure that, there are numbers and there’s more accuracy there.

But this was the only, this was the dip, in that time period.

So we’re looking at a three point six to three point seven, multiple of adjusted EBITDA.

In their add backs, you’ll see that they have some huge add backs and those that’s because the owners really took a chunk out of the business for their salary, and that we’ve been able to confirm through their the w two, documents that we saw.

Others is gross margins.

Let’s kinda go here.

So they’ve got last year thirty six percent gross margins and adjusted EBITDA margins usually in the nineteen to to twenty two percent.

We did factor in that we would, the salary of the owner that he would be willing to take would be ninety percent. I mean, ninety thousand dollars, and he would not need any dividend payments until his his exit whenever that would be negotiated.

Now cash on Are you able to expand the slide shown at about thirty five percent?

Yeah. Sorry about that.

Appreciate it. Thanks.

Yeah. Can make it a little smaller too.

Maybe that works a little. Okay. So cash on hand.

They have, you know, a surplus amount of cash on hand, about I think they have about a little over eight hundred thousand dollars in surplus.

And if you’re looking at the ARs as well, how they do their, their their payments is they will typically have a retention that the GCs hold ten percent of their monthly payouts.

And from that ten percent, they’ll get that sum at the end of their job. So it kinda it skews the AR numbers.

And when I talked to him, he said their ARs are usually ranging from, like, forty five days to sixty days in ARs.

Let’s see here.

Okay.

You can go to the MUDs.

Yeah. MUD score.

Yeah. So for the MUD score, this seller was underneath LOI, but fell out. You mentioned that the majority owner is a bit withered of the process, but he himself, if, they are not able to find the correct partner that he would look to grow the business, find land, and and and grow, the business in that space.

So we put the the motivation at four, the urgency at five, and the distress at three. As far as the lever, legacy is is very important, to them. They have both sellers, between the two, have three sons that work currently in the business now and are willing to stay on, upon close or a sale. So so we put the Lexi at seven, the employee at ten, value alignment at seven, and relationship at five. And the customer concentration as, mentioned previously is forty nine percent.

Close to fifty percent.

We’re gonna take you now to the SBA model.

So if we were to, agree on terms and instill, as mentioned earlier, the seller is willing to roll over ten percent equity, of the property as well as we would seek ten percent, from an from an angel investor for the down payment and a ten percent seller finance. That’ll be seventy percent, via through the the loan. As you can see down below, the cover ratio is one point nine seven.

So we feel pretty comfortable, with that space.

Okay.

And then to the forecast model, remember, we really wanted to make sure that we were conservative here. Even the projections for twenty twenty four actually has a higher revenue. They’re at a five point, five point three is what he was, anticipating that they would do in twenty twenty four. But we wanna just make sure that year one, we’re at seven percent year over year growth, and keep the gross margins and the, percentage of revenue just, you know, pretty modest.

And with that, we estimate, you know, if we buy the company as is at the current price of three point four five, in five years, we could potentially, at a very modest level, be able to, if we did sell in five years, walk away with four point five million dollars.

And so and another thing too is the the business doesn’t have hold a lot of inventory. And secondly, their CapEx, they don’t have a ton of equipment because all they’re fabricating really is the, the aluminum hoist.

And they’re getting the glass install the they got glass delivered by the manufacturer to the job site.

So we put the CapExes at, you know, a fifty thousand roughly per year for, you know, different things of or equipment or cars or things like that that need to be changed out.

So yeah.

Does anyone have any questions? That’s the end of our presentation.

Yeah. Great presentation.

I think the only question I see right now is from Ankar. It says, is it easy to scale employees in this type of business to ask because it seems you do have all the demand slash pipeline set already?

Yeah. So we talked to the owner, and that’s one thing he said. He said, you know, finding skilled field workers are is tough, but it’s doable.

They have the right employees in place for staff, but that’s one thing that we would wanna do. And we even factored it into our forecast as well as what does it look like to hire another lead and get another, installer under him.

But they use agency staff, so they’ll contract sometimes, temporary full time workers to fit the demand.

And then they use local things like Indeed or, stuff like that to find other laborers as well. But, yeah, that is a challenge, and I think that’s a challenge in a lot of construction. But, you know, one that’s possible to overcome with the right skill set and, and funnel.

Right model. Yeah.

So so my question my my first question is, is this in your, is this in your lane? And if it’s not in your lane, are you looking for a strategic investor, not just a capital investor?

Yeah. So, let me go back.

So this is, not in our lane.

One of the reasons why we feel more comfortable with this is because the owner is staying on. And, as you mentioned, we are looking for a strategic investor as well as a capital investor, prefer to to be in one, someone who has experience in the business and specifically, can assist with the actual growth running and day to day operations.

Yeah. And and when we when we talk to the owner, the really great thing about that our conversations with him is we told him straight up, we said, hey. We do not have any glass experience. This is our experience. Or or commercial general contracting, we have experience in, residential, working with general contractors, not being them ourselves.

And so from there, he felt comfortable to say, you know, I’ve built how I’ve built my businesses have been to operate independently outside of me. So he felt like he had the skill set to transfer whatever knowledge, whether it was from a GM who he would hire on his exit or to the owners who he wanted to, to take over part of the his role. So with that con those conversations, we felt pretty comfortable. And but even with that, we still want someone in this field that could really impart. And we’ve been able to have some really great conversations with some people on Protege, about this opportunity.

And so my advice when you’re pitching it is to be very specific that we’re we’re not looking for just a person with money. We’re looking for somebody that has knowledge in the industry that’s gonna be our partner.

It makes you look more sophisticated that you care who the investor is.

And and you do really want somebody that’s got industry knowledge that’s that’s really gonna contribute to the business. I I think I I always teach that the, one of the factors that makes you the best new owner of the business is that you’re excited about the business.

Oh.

And if you’ve convinced the seller that you’re excited enough that he thinks he can train you, then that’s perfect.

And you need to capitalize on that too. And so I would I would double down on talking about the fact that the seller really likes you and you’ve got good rapport with the seller.

May I ask you a quick question there while you guys are mulling?

Could you put up the DSCR screen one more time? I just didn’t grab it in in time.

I think they jammed.

They froze.

Did they freeze?

Yeah. They’re frozen.

Yeah. Yeah.

I guess I’ll have to drop my mic then.

Yeah. They just, just left. It looks like they should be coming back. I see James has his hand up.

Yeah. All I was gonna ask is is, because I had to step away for a few minutes, and I didn’t catch the get a good close at the, one sheet.

But, what was They’re back.

Did they have it?

Hold on one second.

They’re We’re back.

Back in.

Yeah. I’m not sure what’s in there, but we we’re back on. No worries.

Well, welcome back to the party.

Al had a question. Let me make you a cohost again so you can share your where did you go? Hold on.

Let me make you cohost so you can share it. Albrecht, I was asking a question, and then James has one, and then Leonard has one.

Hi, Folly. I I was asking if you could put up the DSCR screen, one more time with a lower portion of the SBA model screen, I think it was.

Hold on one second. I would have to log in through my phone. Sorry. I mean, through my laptop because it’s yeah.

So we’re back on the laptop. So just, log back in and then just log off the file.

Yeah. Sorry, guys. Technical difficulties here.

It happens.

I guess one while you’re while you’re pulling that up, and, we’ll look at that. One one comment that I I had was on the working capital.

I think you said that they were willing to leave five, six hundred thousand dollars of working capital in the business.

I think that’s that’s not near enough to for for what you need. If you look at the burn rate in terms of expenses, it’s a just on average, it’s probably about three hundred and ten thousand dollars per per month that they’re spending in expenses.

And if you look at that AR number and how long it takes to collect, if I’m going going off my memory, I think it’s around a hundred and ten days. So you’ve got almost a three to four month window from when you perform the job to when you’re actually gonna collect on, on those receivables. So you’ve gotta have enough cash in the business as part of your working capital initially to to cover that. So, you know, just take, you know, three hundred thousand times four months, you’re looking at minimum one point two million, and even that’s, you know, stretching it. So I think you really gotta work dig into that working capital number and understand that to make sure that you’re you’re covered with enough cash to to get you through that period.

I thought they had said the account receivable, cycle was, like, forty to sixty days. Am I off on that?

On the on the one sheet, it was, like, a hundred and ten days, I think it was.

Yeah. So on the one sheet, it’s a hundred and ten or a hundred and seven days.

With the way that they do their payments, they collect, like, a retention, every for ten percent per month for their jobs. So that kinda skews the numbers. But, yes, the working capital is something that we intend to negotiate, with the owner.

I’m back on, by the way, and, we can if I can get the share my screen access, I can put a pull up the, the page.

It’s past.

Yeah. And to David’s comment too there real quick, with with there being fifty percent concentration, that that adds a level. So, you know, understanding who that actual customer is that’s not paying, is it that one fifty percent customer? Is it multiple customers that are extending out payments? So understanding who that is and, you know, that’s if if it’s that one fifty percent customer and they’re just, you know, paying whenever they feel like it, you know, that’s that’s a huge risk. And, yeah, financing could could be tough.

Yep. Okay.

Yeah. And it you know, yeah, that that’s a that’s a good point. When I we did speak to the owner, and and we’d have to dig into this a little more too with them, is they’re saying from their standpoint, they get paid by sixty days, once jobs are completed.

And then, also, they have they do have a line of credit in the business of seven hundred and fifty thousand that, they could use, but they usually, by year end, are at zero balances. But they do have a lot of surplus capital in there. So, yeah, we’ll have to dig into that. Thanks.

If someone sure. I could share my screen now if needed. I just need access to be able to do that.

So Alright. You should be able to.

While you’re doing that, if it’s okay to jump in, I just wanna dovetail a little bit on, both the working capital and the customer concentration.

I ran a a contracting business, subcontractor business. It was in cleaning, not construction.

Did a lot of construction cleaning in my earlier years. I hundred percent agree, with Jeremy. I think no matter what anybody tells you, you have to count on ninety days when you’re dealing with general contractors.

That’s just tends to be the the way the way of the world or their world.

The customer concentration, you have to be very, very careful, and you might wanna, even if it means waiting on this deal for a little while, you might wanna wait it out until it becomes more of an annuity deal.

Customer concentration could be the most dangerous thing anybody does in business.

If you’ve got one customer that’s fifty percent and, let’s just say they don’t end up, like, getting rid of you. Okay?

They could also they can smell it, and they know whether they’re your biggest customer by far, and they can put pricing pressure on you. They could do all kinds of things. I’m not saying they will, but they can, and you have to be careful about that. And if you do, god forbid, lose that customer and you have big debt service, then you’re in a in a heap of trouble. So for me, with customer concentration that high, I would look for a lot more seller financing, you know, to to spread the risk a little bit because if you don’t, then all the risk falls on you.

And the first thing you should do when you buy the company no matter what is I remember we tried to put our business up for sale for the first time and the, you know, the boutique, M and A company, you know, they basically said to us, we’ll put together a SIM for you, but you’ve gotta get your customer concentration down below twenty percent. We were at about, I think, third originally about forty percent with one customer, and we got it into the early the low thirties, and we got all excited. And then the investment banker said, nope. That’s still too high. You gotta get it under twenty. So just keep that in mind should you buy this company, but the first thing you need to be doing is to dilute that customer concentration.

Yeah. Thank you.

Thank thing to to to add on that, if the GC and the seller are if they know each other well, which I assume they do, and they have a good connection and that seller can go to that GC and say, hey. I’m looking to sell.

You need someone to put ten percent equity in. So will that g g c invest ten percent equity into the business somehow, and then you partner with them. And then you’ve got them, you know, you’ve got them locked up a little bit, at least, that they’re not gonna go anywhere because they’re investing in the company and a partner of yours.

But Yeah.

It’s a great conversation with the seller.

And and also another thing that you might want cons want to consider doing is have the seller if you can’t get the seller to do more of an annuity deal, have them roll over a much bigger portion of, their compensation.

Because the more they’re tied to the business, the more they’re gonna make sure that they keep that one fifty percent customer. So instead of rolling over ten, maybe they need to roll over between thirty and fifty percent.

So I I discussed this the other day with with, with these folks. So I I think there’s an important point there, Lenny, the ownership of the business is seventy thirty. The the operating partner that runs it owns the thirty percent.

It’s the seventy percent owner that wants to cash out.

The thirty percent owner is willing to roll ten percent, so he’s rolling one third of his.

Got it.

And and he’s the one that’s operating and has the relationships. Am I right about that, Folly? Did I did I remember that right?

Yes. You did. He owns twenty three percent.

But Twenty three.

Okay. So so he’s rolling ten percent of twenty three percent.

Yeah. But, David, from a risk profile, don’t you think that even if that’s the case and he’s gonna he’s gonna roll over ten of his twenty three percent into the new co, that that one customer, even though the this gentleman, the operating partner has the relationship, it’s still, in my opinion, a pretty scary position to be in.

All things can affect, even if the general contractor that that is the big customer is not nefarious.

You know, you have a lot you know, construction’s very influenced by macroeconomic conditions.

And, you know, if you’re taking on a a a boatload of debt and all of a sudden that general contractor, you know, even if he halves the amount of business he gives you, that could be, that that could just destroy your debt service coverage ratio.

Yeah. No. No. I def I definitely think there’s a significant risk, in in the, in the concentration.

I just wanna make sure that that, you know, I I think it it is a mitigating factor that the operating person, you know, is rolling fifty percent of his time or or or close to it. I mean, I think that I think that is a good sign, but it’s still a big risk. And particularly when you, you know, as I said earlier in the comments, you rolled you rolled the receivables, turn rate, and the concentration and understanding how much of that, receivable is at risk. Because, I mean, look.

Just because they’re a giant global contractor and and just because they’ve been in business for a hundred and fifty years doesn’t mean they don’t go bankrupt.

Bechtel here in Texas is in bankruptcy right now. They’ve been in business since eighteen ninety.

Yeah. And they had they had one big project. They’ve they’ve got an LNG project, down on the coast that that that weighs in a whole company. Looks the other year. No. Just because they’re big and they’ve been around forever doesn’t mean that they can’t fail. Awesome.

Everybody, thanks thanks for the comments on on this deal and and and questions. Great job. Great presentation.