The Art of Buying and Selling Companies in the Natural Products Market

Consolidation is nothing new to growth markets. From the late 1990s to the mid 2000s, the organic industry underwent rapid consolidation, as the likes of Kraft and Dean Foods snatched up small, successful organic producers and manufacturers. The dietary supplement industry has also undergone cycles of consolidation, from last decade’s pharmaceutical invasion—such as the monumental Solgar-American Home Products (now known as Wyeth) deal—to the more recent acquisitions of supplement manufacturers by companies within the natural products industry. In an industry where start-ups are rampant and growth still attainable, especially in certain niches, where will the next merger and acquisition (M&A) deals be?

INSIDER asked Paul McGarvey, a founding member of Cybus Capital (www.Cybus.com), for his take on the current M&A situation in the natural products industry, including some tips on what buyers look for in companies. Cybus is a division of First National Investment Banking located in Des Moines, Iowa, which specializes in providing capital for natural and organic food and health and wellness companies, as well as renewable energy and green manufacturing start-ups. McGarvey has been involved in LOHAS (Lifestyles of Health and Sustainability) for the past 10 years.

INSIDER: How did Cybus first get involved in the natural and organic foods category?

MCGARVEY: Cybus got its first exposure in the category in 1999 through a private equity initiative, Tecterra Food Capital Funds, which was created to promote value-added food processing and manufacturing in the state of Iowa. We invested in a Boulder, Colo.-based company called Rudi’s Organic Bakery, which successfully grew to the point where a new private equity fund, Charter House Bakery out of New York, was able to purchase it and take it to the next level. In addition to Rudy’s, we were involved with Wildwood Natural Foods, a Watsonville, Calif. - based organic tofu and soy yogurt manufacturer. The next engagement was Supreme Packing, which today is one of the largest purveyors of organic and natural pork in the country.

INSIDER: How has the natural and organic category changed since Cybus first entered this segment?

MCGARVEY: The market has virtually exploded. Today it’s a $17 billion industry on the food side alone, which represents about 3 percent of retail grocery, with 15-percent to 20-percent annual growth and exceptional margins. This has been fueled by an expanding population of baby boomers with growing disposable income in both North America and Western Europe.

These educated consumers are very aware of the health impacts of pesticides, preservatives, antibiotics, hormones and genetically modified foods. So, what started out as a niche has now converted to mainstream. The market continues to expand and broaden its appeal to the point today where mainstream retailers like Wal-Mart offer an array of organic products.

INSIDER: How has natural products companies’ need for capital changed?

MCGARVEY: The companies that have been successful and have grown rapidly have been quickly acquired by multinational food companies or private equity firms. Those companies that remain independent today are smaller and quite entrepreneurial. The industry is still dominated by companies with less than $20 million in annual revenue. There are still larger, more mature companies being acquired, but there are fewer of them than when this consolidation trend began.

INSIDER: What do you look for in clients in the natural foods category?

MCGARVEY: We look for the same things in natural foods businesses that we look for in the traditional food sector. That is, they are what we call “institutionally ready” to receive capital. They have a management team that has demonstrated success in the past and are well positioned to take this business to a higher level. What we’re looking for—and what potential acquirers and investors are looking for—is high growth, high margins and high returns on invested capital. Last, but not least, we’re looking at SPINS and other consumer spending data for evidence of growing consumer acceptance and market penetration—nationally, not just locally or regionally.

INSIDER: Will the trend toward mass consolidation in the organic market continue with natural foods companies?

MCGARVE Y: There is an imbalance in the marketplace today with too much money chasing too few deals. As a result, you’re going to see higher multiples. I don’t see it changing near term.

INSIDER: So is now a good time to sell?

MCGARVEY: Yes. It’s similar to the trend we’re seeing in the traditional M&A market. But in the natural and organics sector, there are unusually high valuations for these businesses. Again, there’s a lot of capital out there looking for unique and well-managed businesses.

INSIDER: There are obvious benefits to growth, but are the re also risks?

MCGARVEY: The challenge is to receive capital and grow your company in a fashion that doesn’t inadvertently destroy it. Cybus works to prepare clients for the capital-raising process and advise them on how to establish the structure that must be in place to use capital successfully.

INSIDER: What things should a natural foods company do to be ready for a capital infusion?

MCGARVEY: Great question. Companies come to us and tell us they need to raise money or sell their businesses, but often they’re clearly not ready to do so. Acquirers and investors demand audits and/or reviews of the business, not just tax statements. And they want meaningful business projections.

Without basic financials of this type, they’re not in a position to address capital needs and/or valuations.

INSIDER: Does Cybus have a checklist of the information required?

MCGARVEY:  Yes, we ask for a three- to five-year financial profile, historical financials, balance sheet, P&L (profit and loss) statement, cash flow statement, business plan, ownership structure, and projections for the next two to three years. We want to understand specifically how they value their business and their overall objectives and goals as they guide their business forward. We also look at the management team.

Often we see a company run by one individual who is president, CEO, CFO, sales and marketing, etc. — good management is the key. You want to see someone who has some sense of what’s involved in taking the business to the next level. It’s also very helpful if the company has solid advisors, including an active board. Basically, we’re looking for small companies that can realistically develop into larger businesses that can support the expectations of investors.

INSIDER: Does Cybus have a size limit for the companies that it will work with?

MCGARVEY: We look for businesses with at least $10 million in revenue. In the natural segment, however, you often have to share some of the vision that the business owner has. We’ve worked with businesses with less than $5 million in sales. In fact, we’re doing a pre-revenue business right now. There are large dollars out there, but they are generally chasing larger businesses that have a minimum of $1.5 million to $2 million in earnings.

INSIDER: So, experience in the natural products industry is important when evaluating an investment bank?

MCGARVEY: Yes, because experience in the category translates into longstanding relationships with capital sources that understand and appreciate the potential of this industry. We have worked with the investment community in this sector for a long time, and they have grown to value our analysis of potential opportunities. They know we understand their funding criteria and have a reputation for bringing them deals that fit their objectives. Our Midwest roots are also a plus, because the innovative, new green businesses, such as biofuels and PET packaging, that are spinning out of traditional agriculture, are in our backyard.