Let's discuss the practices banks are using to benchmark carriers and brokers. What is benchmarking? When you're pursuing any kind of merger or acquisition, banks are typically involved. They'll look at specific key factors in determining the value of your business. In turn, they'll use these factors to make accompanying underwriting decisions. Often, the conclusion they reach during this benchmarking process will be the difference between the completion of a merger or acquisition and its failure.
Here are some of the details we'll look at:
Before we cover this in depth, let's discuss some of the basic terms.
Let's keep this section brief, but it's important that you understand the roles of carriers and brokers in transportation. Let's a take a quick look at each below:
Now let's get into the more sophisticated financial part of this.
Before we can dive into how benchmarks value your business, we need to address mergers and acquisitions, or M&A. Currently, the trucking industry is rife with M&A. The existing market has seen rates drop, capacity dwindle, and competition for quality drivers increase. In turn, smaller companies are desperate to sell. Fortunately, larger companies have been eager to buy. However, even though the market has been strong for M&A, there are many factors to consider before making such a significant transaction.
The industry reasons for this mirror those above. The acquisition of assets and drivers is often worth the price alone. Beyond that, absorbing preexisting customer relationships is extraordinarily valuable. However, there are many financial factors that you must take into account first.
Next, we'll dive deep into what those factors are. These are benchmarks that parent companies and banks use before pulling the trigger on any M&A.
What methods do companies and banks use to decide how much a business is really worth?
There are three major methodologies to business valuation.
Many subcategories fall within each of these methods. Often, a company or bank will use more than one in making a business valuation. However, for our purposes here the most relevant and most commonly used approach is market methodology. So, within that framework, let's look at some of the broadest key factors used within market methodology to benchmark your company's value.
Below, you'll see a list of some common benchmarks that banks and parent companies are looking for in valuing your business.
In a buyer's market for M&A, these factors will be more important than ever in securing an acquisition. How your company measures up against your competitors will help determine whether you're able to complete the merger or acquisition. You're aiming to outperform the standard industry benchmarks. If you do, a bank will be more likely to underwrite you.
Now, let's look at some of the most important benchmarks in detail.
Businesses measure profitability in a variety of ways. While overall profitability is what's left after subtracting expenses from overall revenue, there are more specific data points to watch for. For example, you can measure profitability by operating income margins. Also, you may measure profitability by net income margin. Finally, you can look at profitability by EBITDA. This is your earnings before interest, taxes, depreciation, and amortization. EBITDA measures a company's overall financial performance. That said, EBITDA can also be a misleading figure. Why? Because EBITDA takes out the costs for investments like property and equipment. Therefore, it can give an incomplete portrait of a company's overall health.
Cash flow is essentially the overall net total of cash and cash equivalents being both brought in and sent back out of your company. Ultimately, positive cash flow is one of the biggest key indicators of a business's value. Positive cash flow means there's a surplus of cash for the company. You can then use this cash to pay shareholders, settle debts, or reinvest in the company.
Your market share is how big of a piece of the industry pie that you have. So, if you divide your company's sales over a set period by the total industry sales over that same period, you find your market share. This is a great indicator for where your business stands in relation to your competitors.
If you divide your total company liabilities by shareholder equity, you find your debt-to-equity ratio. Businesses and banks use this metric to help determine how much of your business you're financing through debt versus in-house funding.
Finally, your balance sheet is a comprehensive financial report of your business. In other words, this sheet is a snapshot of all that your company owns and owes. Furthermore, it details the amount that shareholders have invested in the company.
These are just a few of the important benchmarks banks will use when deciding whether to support your company in M&A. Now, let's discuss how banks could underwrite your company.
First, let's discuss exactly what underwriting means in M&A. Let's start with what an underwriter does. Chiefly, underwriters are risk assessors. By figuring out the likely risk of each side in a transaction, they establish a fair and stable market for financial transactions.
So, let's apply this to your trucking company in M&A. An investment bank would buy shares of the company that wants to sell shares. Then the bank would sell those shares in the marketplace. The benefit to this is the bank ensures the company reaches the capital it needs in order to be acquired. In turn, the bank wants to turn a profit for the service.
Therefore, the underwriting process for banks involves risk assessment. Their underwriters use all the benchmarks we discussed earlier to determine the risk of underwriting your company.
In the ever-evolving transportation market, you may find M&A to be the best path forward for your company, yourself, and your employees. This may be particularly likely if you're a smaller company struggling to find a profitable long-term plan. Now you know your necessary areas of focus because we've discussed what benchmarks banks use when deciding to underwrite your company. You need to show that you provide value as a business. Your value needs to be apparent to both a potential purchaser and an investment bank.
Quality organization skills and efficient business operation (often through wise use of technology) will be essential in reaching these goals. Generating strong revenue as well as having a clear and impressive balance sheet, positive cash flow, and a low debt-to-equity ratio will be especially strong factors. If you stay vigilant, organized, and prepared, you'll have no trouble proving your business's value.
This post was written by Matthew Zandstra. Matt has been working in transportation and logistics dispatch for the past six years, both as a broker and direct to drivers. He’s familiar with various facets of relationships, technical systems, pricing mechanics, and commodities.