The Book I Write Myself

There were two bridges on my desk describing the same company. The banker's started at reported EBITDA of three point one million and climbed through seven adjustments to four point eight. Mine started at the same three point one and walked the other direction, down to two point six, and the distance between four point eight and two point six was about to become the entire negotiation. The company was a gear shop, forty people, hobbing and grinding for customers that mostly arrived during the first Bush administration and never left.

For years I negotiated the other way, against the banker's bridge, disallowing add-backs one line at a time like a man haggling at a market stall. It worked badly, and it took me an embarrassingly long time to understand why. Arguing about his adjustments concedes that his document is the reference point, and whoever owns the reference point owns the negotiation. I was playing away games exclusively and wondering about my record.

So I stopped. The CIM gets one honest read now, for the table of contents and the customer names, and then it goes in a drawer. The two pieces before this one covered the genre and its leaks: the book is advocacy, and the operating paper underneath it tells the truth. This one is about what the truth is for. Over about a week, I turn it into a book of my own, and that is the number I price from.

Start With the Invoices

Revenue gets rebuilt first, from the invoice file, sorted by customer, part, and month. The question the sort answers is durability: which revenue is a machine that will run next year, and which was an event that already happened. On the gear shop, the banker's growth story leaned on the best year in the company's history, and the invoice file showed why it was the best year. A single customer had paid for a program's worth of tooling, one time, at thin margin, ahead of a launch. The book counted it as growth. I counted it as a loan the customer had already repaid.

The same sort separates the aerospace slice from the aerospace customer, the recurring part numbers from the emergency orders that happened to recur, and the price increases from the volume the price increases quietly cost. None of this is sophisticated. It is a week of evenings with a pivot table, and at the end of it you know the revenue the way the billing clerk knows it, which is better than the way the CIM knows it.

The quote log then tells you how durable the durable revenue actually is. A part that has been spec'd into a customer's assembly for fifteen years, with the fixture on the shelf and the first article paperwork in a drawer, gets requoted approximately never, and that inertia is worth a multiple point on its own. A part that goes out for competitive bid every year is revenue on a twelve month lease. The invoice file cannot see the difference. The quote log can, and reading the two together is where the rebuilt revenue number earns its confidence.

A Bridge With My Name on It

Then the bridge, rebuilt from the operating paper. Some of the banker's adjustments survive contact. Owner compensation marked to a market general manager is legitimate, and so is the actual one-time item, the roof or the lawsuit, the kind of thing that has a date and a receipt and no siblings in the prior three years.

The reversals are the quiet ones. Maintenance that went silent two years ago comes back into my bridge as a subtraction, priced off the rebuild schedules of the five machines that matter rather than off anyone's estimate. The plant manager the owner never hired, because he was the plant manager, goes in at a market salary. The building the company rents from the seller's own LLC at half of market gets marked to the lease he will be asking for at closing. Scrap running at eight points gets left exactly where it is, because my bridge prices the business as it runs today, and today it runs at eight.

Capex gets the same treatment, because the model's capex line is the most fictional number in most deals, a smooth percent of revenue drawn by someone who has never bought a spindle. Mine is built machine by machine from the equipment list and the rebuild schedules: which machines need work in year one, what the work costs, and which one is due for replacement before the seller note matures. On the gear shop, that exercise moved half a million of year one capex out of the model's gentle assumption and into the purchase price conversation, where it belonged.

My number usually lands below reported, which surprises sellers and almost never surprises their controllers. The controller has been watching the deferred rebuilds and the below-market rent the whole time. Somewhere in every process there is a person who already agrees with your bridge, and it is rarely anyone in the room where the bridge gets argued.

Whoever owns the reference point owns the negotiation.

Paul W. Swaney III

Pricing What I Can Fix

The rebuilt number is the business as it stands, and standing next to it is a second list, mine. Scrap at eight points that I know how to walk down to three, because I have done it in shops with the same processes. Overtime concentrated in two work centers that a scheduling change would mostly erase. Pricing that the founder last raised apologetically, years ago, across the board, by less than his costs had moved. That list is worth real money, and I decline to pay for any of it.

The seller is entitled to the full value of the business he built, priced accurately off a bridge with receipts. The work I am going to do after closing belongs to me, along with its risk. Paying the seller today for improvements I will sweat out of the plant over two years is the quietest way to lose money in this business, quieter even than overpaying for the massage, because it feels disciplined while you are doing it. The most expensive sentence in private equity is some version of: it is in the model.

The Gap Is the Conversation

When the two books disagree, the gap becomes the negotiation, and the negotiation changes shape. I bring my bridge with the receipts stapled to it: the rebuild schedules, the invoice resort, the lease comp, the scrap reports by month. Bankers are professionals, and they treat a documented bridge professionally. The conversation stops being adjectives against adjectives and becomes document against document, which is the fight the prepared party wants.

Sellers sometimes answer a documented bridge with the oldest line in the process: another buyer will pay the book number. Sometimes one will, and my response is to mean it when I say I hope he does, because a buyer who pays the massaged number for a plant with a silent maintenance log has done me two favors, removing a deal I would have regretted and reminding the banker which buyers close at the numbers they open with. Underbidding with receipts is a reputation strategy. Bankers remember who wasted their time, and they also remember whose diligence held up after close.

Some deals die at that table, and they die cheaply, which is the second best outcome available in this business. The gear shop closed at a number that sat closer to my bridge than to his, with a seller note bridging the last of the distance, and the operating plan was already written because the diligence had written it. Integration started the Monday after close with the maintenance backlog as the first agenda item. Nothing about the process was adversarial, because nothing about it was a surprise. Both sides had spent months looking at the same paper, and paper, unlike adjectives, converges.

What This Means for a Fundless Sponsor

A deal team inside an institution cannot fully run this play, and it has little to do with talent. The memo must anchor to a citable document, the citable document is the banker's, and so the committee debates his adjustments because those are the lines it can point to. The associate who rebuilds the revenue from invoices has produced judgment, and committees, as the key man piece argued, underwrite evidence. My capital and my consequences sit in the same chair, which means my own bridge is allowed to be the reference point, provided I did the work to earn it. The play is also faster than it sounds. The week I spend rebuilding is usually finished before an institutional buyer has negotiated the QoE engagement letter.

This series started in a room with a beautiful bridge and a younger version of me mistaking craft for fraud. The banker did his job. The freight bills and the maintenance logs told the truth the whole time, waiting to be read. What remained was to write the book that prices the deal, and that one has to come from your side of the table. It is the only document in the process whose author you can fully trust, and the only one that gets better every time you walk a floor.

Paul Swaney is the founder of Swaney Group Capital, a fundless sponsor focused in the lower middle market. LeverUp® is published weekly. More if I have something else to say.