Early in my acquisition journey, one critical aspect that caught me off guard was CAPEX (Capital Expenditures). Here’s what I learned about managing and understanding CAPEX in potential acquisitions, and how I help my clients get up to speed.
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CAPEX Isn’t Always Obvious: In many deals, CAPEX can be hidden or not explicitly listed in the CIM (Confidential Information Memorandum) or P&Ls (Profit & Loss statements). Instead, it often appears in the Balance Sheet or Cash Flow Statement. This can make it tricky to get a clear picture of the business’s financial health.
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Look at Depreciation Numbers: A good hack is to examine the depreciation figures. If these numbers are high, it’s a signal to dig deeper into CAPEX. I’ve found that averaging depreciation over the years can provide a rough estimate of maintenance CAPEX if other financials aren’t available.
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CAPEX and Growth: Understand the business’s CAPEX needs for both maintenance and growth. In my case, I discovered that an event and contractor equipment rental company needed to spend at least $1 million annually on new equipment, which wasn’t reflected in their P&Ls.
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Ask the Right Questions: Don’t be afraid to ask detailed questions about CAPEX. During one of my site visits, I noticed discrepancies in the reported equipment spending. The owners admitted, “Oh, that’s not right,” when I pointed out inconsistencies. Always verify and double-check these figures.
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Impact on Free Cash Flow: Understanding CAPEX is crucial for calculating the true Free Cash Flow (FCF). In my experience, what initially seemed like a robust $3.2 million in EBITDA was closer to $1.6 million in free cash flow after accounting for necessary CAPEX. This significantly impacted my decision to proceed with the deal.
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CAPEX and Business Viability: Realizing that future growth would be capital-intensive can influence your decision. For example, in my rental business deal, every new location required significant investment in new equipment, impacting the overall business viability.
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Learn from Each Deal: Every deal provides valuable lessons. My experience taught me to integrate CAPEX considerations early in the evaluation process. Understanding how CAPEX affects cash flow and business operations is crucial for making informed decisions.
Takeaway:
CAPEX is a vital component in acquisition deals that can significantly impact a business's financial health. For searchers, it’s essential to:
- Scrutinize depreciation figures.
- Ask detailed questions about equipment and infrastructure spending.
- Understand how CAPEX affects free cash flow and future growth.
- Be prepared to adjust your evaluation based on these insights.
By staying vigilant and thoroughly investigating CAPEX, you can avoid surprises and make more informed acquisition decisions.
The other thing I see from time to time is equipment heavy companies with large annual CAPEX spends where there does not appear to be enough free cash flow after a CAPEX adjustment to support the purchase price or even the value of the equipment currently owned in a new loan. Due to the amount of on-going equipment cost, some of these businesses are not really as profitable as they seem when you strip out depreciation or add in CAPEX costs.
Always happy to look at any deals and see if we can provide guidance on CAPEX needs. You can reach me at --@----.com