The Private Equity (PE) community is an important source of capital for exiting private business owners and in recent years, have been increasingly active in the Produce Industry. For example, Agribusiness-focused Blue Road Capital recently acquired B&W Quality Growers from Boyne Capital. Additionally, HKW acquired Fresh Direct Produce (and has since made a couple of add-on acquisitions) while Butterfly Equity acquired Bolthouse Farms earlier this year. While not for everyone or a fit for every situation, this blog article will outline some of the key factors that may impact the value of a produce business when considering taking on a PE partner.
While most PE firms are ostensibly looking for opportunities where their team can add value by implementing operational improvements, the use of debt financing and the acquired company’s ability to pay down that debt can also be important. Ideally, the target has a leverageable asset base with relatively consistent and predictable cash flow. This means that it is critical for the acquiring PE firm to understand the stability of a candidate’s customer base. A high degree of customer concentration, or limited recurring revenue, may be a sign of unreliable future cash flow; impacting the PE firm’s ability to use debt effectively. This increases the cost of capital as the PE firm needs more equity capital to finance the transaction; ultimately lowering the PE firm’s return of equity (ROE) unless they get a corresponding reduction in the purchase price.
In the Produce Industry, reliance on big retailers or foodservice customers can be a challenge. Maintainable and reliable cash flow can also be impacted by production and supply issues. A diverse and reliable customer and supply base will help increase the probability of obtaining competitive valuations from PE firms.
Another key factor affecting future cash flow is the capital expenditure (CapEx) requirements of the business. For example, produce businesses that rely heavily on hard assets like cooling, harvesting, packing and handling equipment need to regularly replace aging assets; further reducing free cash flow to pay down debt. Some produce businesses, like greenhouse operations, rely heavily on CapEx to grow and expand the business, as production is usually already at maximum capacity for a given square footage.
Of course, like everything in life, there are always exceptions. We know of many Private Equity firms that understand the inherent challenges in the Produce Industry. Rather than relying on the extensive use of debt to “financially engineer” a suitably sufficient ROE, they focus on acquiring businesses with talented management teams, so they can work cooperatively to develop growth opportunities, grow EBITDA margins and help the business expand through strategic investments in operations to diversify their revenue and suppliers.
If you missed Part 1 of this blog series and want to catch up, you can read it by clicking here.