Big Red Car here.  Cold day in the ATX.  Nice crisp, bluebird day.  What a breath of fresh air.

Spring is right around the corner.  This morning when The Boss and I went out for coffee, I saw some azaleas starting to blossom.  We are about 3 weeks from azalea time.

So The Boss gets a question — where do you find these Old Economy companies to transform into New Economy companies?

Pretty good question.

What kinds of companies?

Remember first of all that you want a certain kind of company.  Not every company is going to be susceptible to the charms of your transformational love.  You have to find the RIGHT company.

Start with industries that have an established way of doing things, lots of customers and which upon first review are going to be worthy objects of the transformational dynamic you are going to employ.  Maybe a company in an industry that you actually know something about.  Leverage your knowledge.  Why the Hell not?

The “established way of doing things” is part of being an Old Economy company because you are going to be “disruptive” to that industry and that individual company.

You need lots of customers because you are going to influence customer behavior through the deployment of social media and other modern marketing techniques.  You need a lot of customers so that when you increase the frequency of customer visits and when you increase average spend — two very important metrics to measure, impact and increase — you achieve meaningful financial improvements from the existing customer base.

Part of this transformation can provide instant gratification if done correctly.

Remember this — you are looking to improve the bottom from the existing customer base not just through growth of customers.  This is the low hanging fruit.

Once you have made the transformation to a New Economy company, then you are also going to grow the customer base.  Three objectives at work here:

1.  Increase the frequency of all customer visits — focusing in particular on your 15% top customers as measured by average spend per visit.

2.  Increase the average spend of all customers.

3.  Increase the number of customers.

OK, so Big Red Car — you still haven’t answered the question — what kind of companies?

Fair play to you faithful reader:

1.  Service businesses with the ability to increase their size based upon the addition of incremental units — particularly in home services (landscape maintenance, pest control, pool maintenance, garage door installation);

2.  Small manufacturers whose futures are held hostage to capital constraints and marketing staff size (specialty paint manufacturer, secondary after market manufacturers, industry specific parts stores) ;

3.  Food service of all kinds in which financial results can be achieved as noted above (pizza joint, bagel shop, burger joint, franchise operations, sandwich joint, bakery);

4.  Retailers of all kinds in which the addition of more units — scale — can drive results (specialty clothing, mini-superstores, kitchen/bath, barbecue appliances);

5.  Businesses which provide a “hard” service but which have an element of people focus (pool gunite installation, pool design/construction, decorative concrete) ;

6.  Entertainment businesses of all kinds (game stores, bingo parlors, child game venues); and,

7.  Businesses which have an almost fixed overhead regardless of how many customers they have.

In many ways, you are looking for solid businesses which may be attractive because of their absolute total lack of glamour.  You want glamour — go start up a web based product business.  Not the same thing.

Important characteristics

There has to be a reason why the business is for sale to make it a good opportunity.  Here are some “good” reasons.

1.  The owner has no succession plan and wants to sell because of age.

2.  The owner wants to retire and there is no “next” generation interested in the business.

3.  The owner’s health has begun to impact the business operations.   The owner is sick or otherwise disabled.

4.  The owner has passed away and the business is in an estate.

5.  The owner’s spouse has passed away or is very sick and the owner is distracted by the realities of this situation.

6.  The owner has been chasing blondes and has gotten caught.

7.  The owner is going through a divorce and must unlock equity to be able to deal with the financial implications of the divorce.

8.  The owner is in some kind of financial, regulatory or other legal trouble and has to sell.

9.  The capital structure of the company has changed substantially and the owner cannot solve the balance sheet problem.  But you can.

10.  The company’s financial trend is not favorable perhaps simply because of the realities of the economy.

11.  The skill set of the owner is not competitive given the changes in technology and marketing — the very changes you intend to deploy.

There has to be a reason why the company is in play or should be in play.

Validate that reason.

What are you not looking for?

If the target company is run by an old guy who has sent his kids to Stanford and Wharton and they live in town — DO NOT BUY THIS BUSINESS.

You have to have an Old Economy company to be able to transform it into a New Economy company.

If the company is already a New Economy company, grasshopper, pass on the deal.

Where do you find them?

So where do you find these companies, Big Red Car?  Where?

1.  Talk to every business broker in town.

2.  Talk to every small brokerage firm which fancies themselves as “investment bankers”.

3.  Visit with the heads of every bank in town and get into their “troubled assets” department.  They will become a matchmaker.

4.  Look at the obituaries and identify any business owner who has passed away.

5.  Read the local business journal and sniff around for trouble.

6.  Look at your targeted industries and talk to local industry groups and associations.

7.  Take out an ad in an appropriate publication plainly stating your interest.

Simple answer — follow your nose but get your nose headed in the right direction.  Part of the value creation opportunity at work here is the discovery process.

A great discovery process can find a real diamond in the rough.  Go find that diamond.

The business you want to find is the one that has the right reason to sell but has not yet initiated the sales process.

How do they trade?

You want to make the trade on a rational basis that allows you to get in at the right price.  Sometimes that is the key to creating real long term value.  You made a damn good buy.  Here are some touchstones.

1.  Buy at 2-3 times TTM (trailing 12 months) cash flow with a fair cost of management included in the expense structure.  Could you argue for 2-6 times TTM cash flow?  Sure.  Just don’t get sloppy.

2.  Get the owner to finance the transaction.  Try to pay 25% or less cash downpayment with a 5-7 year note at a low interest rate and even a longer term amortization.  Non-recourse.  Make leverage — financial leverage — your ally.  The seller often wants an annuity as he depends on it to live on.  Taxes will also drive this decision.

3.  Negotiate your best deal and then get a meaningful discount for paying cash.  Get an option to pay it all off at a meaningful discount in years 2-4 of the note.

Is this realistic?  Well The Boss has done it literally over a hundred times in different industries.  So, yes, it is realistic.

It has to be the RIGHT deal.

So, there you have it, grasshopper.  A bit of a road map to help you find your Old Economy company.  Good hunting.

But, then again, what the Hell do I know anyway?  I’m just a Big Red Car.

Be good to yourself, you deserve it.