Lesson #289: Our First Acquisition--Red Rocket Acquires Restaurant Furniture Plus

March 08, 2018




As many of you know, Red Rocket has been looking for a business to acquire for the good part of the last two years.  I previously wrote about all the challenges and hard work you can expect when doing M&A related projects, so I won't repeat those. But, I am excited to announce, Red Rocket closed our acquisition of Restaurant Furniture Plus last month, in partnership with Kessler Warshauer Ventures.  And, what a wild ride it was, getting our first acquisition to the finish line.  Let me elaborate with a few learnings from this process for your educational benefit.

OUR OVERALL M&A PROCESS

In the last two years, we looked at over 260 businesses for sale.  We made offers on around 20 of them.  That is a lot of hours invested to simply find 8% of them that were interesting enough to make an offer.  From that list of offers, we agreed to financial terms, and started a formal due diligence process with around 6 of them.  And, we got one to the finish line, successfully unscathed through the due diligence process and negotiations of the formal purchase agreements.

IT'S NOT A DONE DEAL, UNTIL IT'S SIGNED

At one point or another, over the last two years, I would have thought, with 80% certainty, that I was approaching the finish line towards acquiring a pet supplies, beauty products, candy maker, auto leasing, educational toys, and fitness video business.  But, there are many reasons why these deals did not close.  We learned something bad during due diligence.  The seller gets scared away by the agreement terms.  The seller tries to increase the price, after agreeing to a lower price in the letter of intent.  And, in one case, the seller liked our plan so much, they decided not to sell and try to grow the business themselves with our plan!  So, the deal is never done until the agreement is signed by both parties, as the process is laden with many potential pitfalls along the way.

OUR CRAZY MONTH OF NOVEMBER

Normally, serious conversations are pretty well spaced out.  So, with 20 offers made in two years, a normal spacing is around one big deal a month.  But, in November 2017, it was insanity.  We had six different deals that were all in competitive bid situations that we needed to pick one to focus on, and risk losing the other five deals in the process.

We originally passed on Restaurant Furniture Plus, picking a pet supplies business doing creative Facebook marketing, with a very large customer list, that was being sold at a very attractive purchase price.  But, we learned in due diligence that their Facebook marketing economics were deteriorating, the customer email list was really very low quality and with a declining profit base, the purchase price multiple of earnings was increasing by the day.  So, we passed on that deal in the 11th hour of negotiating the agreement.

We went back to Restaurant Furniture Plus and one other business to see if they were still available.  But, they were already under letter of intent, and off the market.  So, we focused on a candy seller on Amazon, that we liked their proprietary branded product line and their attractive purchase price.  But, when we learned their private label product was really branded candies by other manufacturers, that the purchase price did not include inventory (taking the purchase price way up) and there were scores of negative product reviews online speaking to the quality of the product, we got nervous.

At that same time, Restaurant Furniture Plus called back saying they were unhappy with their buyer, trying to change the purchase price last minute, and asked if we were still interested.  We always liked this business, and decided to shift direction and strike the deal with them.  So, I guess the third time of talking with them, really was the charm!

WHAT WE LIKED ABOUT RESTAURANT FURNITURE PLUS

As a lesson for what to look for in a good acquisition, Restaurant Furniture Plus really had it all.  They were serving a big market with a clearly differentiated service offering.  They had terrific unit level economics, with a high return on marketing investment.  They were growing over 67% per year, with a 50% conversion rate on leads, and a loyal repeat customer base making up over 50% of their orders.  It was a lightweight fulfillment model, with very little working capital needed, as their suppliers dealt with inventory and warehousing needs.  The founders were really smart and impressive, with terrific procedures in place, making it simple to transition.  And, it was a way to satisfy my marketing itch, with a service-driven B2B business model that was not going to go head-to-head with Amazon in the B2C space.

OUR THOUGHTS ON THE E-COMMERCE SPACE

With Amazon controlling 65% of all shopping searches, it is really hard to compete with their marketing muscle and pricing power.  Especially with Chinese manufacturers starting to sell direct on their website at wholesale prices (re-read this post about this threat to U.S. ecommerce companies).  So, to be successful in e-commerce, in the era of Amazon and Alibaba (re-read this post about Ali Express's threat to U.S. ecommerce companies), we think you need a couple things.  First, a proprietary branded product or service that you can call your own (preferably not manufactured by overseas suppliers selling the same product to others or themselves on Amazon).  Second, you need to find a category that Amazon isn't going to want to dominate themselves.  Restaurant Furniture Plus offered us both of those things.

KEY LEARNINGS ABOUT SMALL CAP M&A

As for a few learning to share about the small cap mergers & acquisition market, it is materially different than the middle or larger cap markets.  First of all, the entrepreneurs have typically never sold a business before, so they are new to the process, and unknowingly create a lot of friction to getting a deal done (e.g., having never seen a purchase agreement before, which can be scary to them).  And, secondly, they are typically not getting great advice from often less-experienced business brokers (which was not the case with Restaurant Furniture Plus, who was instrumental to helping us getting the deal done).  So, do your homework before engaging a business broker, to make sure they are really good at getting their clients to the finish line.

Compare this to bigger companies.  When a business is put up for sale, it is really for sale with low odds the owners change their minds (so low odds  you are wasting time, spinning your wheels).  And, the investment bankers are much more sophisticated at bridging the gaps and getting both parties to agree on deal terms.  Not to mention the stability and professionalism that comes when buying later stage, higher cash flow producing businesses that have their documents in place, which makes due diligence much easier.  It was frustrating for me being a former big-bracket investment banker at Credit Suisse, running through a process like this.

KEY LEARNINGS POST CLOSING

Make sure you have all your ducks in a row in how you are going to handle your post-closing training and transition period.  There is a LOT to learn in your first 30 days, if you are lucky enough to get that amount of time from the seller.  Make sure you have the right list of topics to get trained on.  And, the right list of technologies and other assets that need to be quickly transferred.  And, make sure the founders are on board to assist as consultants for some period of time after closing.  Preferably, a seller who is flexible to work with you when things ultimately go wrong when trying to transition systems, bank accounts, credit cards, supplier accounts, payroll processing, etc. on a flip of the switch.  Don't plan on running the business for the first month, as you will be knee deep in transition items.  And, the smoother the transition, the less opportunity something falls through the cracks to create problems for you down the road.  And, the first thing to do--hug all your new employees that you plan on retaining, with material incentives, as they will ultimately dictate your success or failure.  You don't want them looking for the door, the minute you arrive, or else you are toast as all their institutional knowledge walks out the door.

OUR PLAN FROM HERE

So, we are obviously excited to have our newest company in our portfolio.  And, I am personally excited to get back into a CEO role again, alongside my partner on this deal, Art Kessler.  But, Red Rocket will continue to be business as usual.  As you have business needs, continue to bring them our way, and our team will be happy to help.  I will do my best to keep the new blog posts coming on a regular basis.  We very much look forward to this new adventure.  And, if you know any restaurant chains looking to source new furniture, you know where to send them!!


For future posts, please follow me on Twitter at: @georgedeeb.



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