How Buyers Value Your Business – 10 Key Factors

September 16, 2011

“I am glad that I paid so little attention to good advice; had I abided by it I might have been saved from some of my most valuable mistakes.” Edna St. Vincent Millay


If you are considering selling your business this article will help you evaluate your company as a strategic acquirer might. From that perspective it pays to focus on ten critical areas of value creation. The better your performance is in these areas, the greater the selling price of your business. Below is our list of STRATEGIC VALUE DRIVERS:


1. Customer Diversity – If too much business is concentrated in too few of your customers, it is a negative in the acquisition market. If none of your customers accounts for more than 5% of total sales, that is a real plus. If you find yourself with a customer concentration issue, start focusing on a program to diversify.


2. Management Depth – An acquirer will look at the quality of the management staff and employees as a major determinant in acquisition price. You should make the move of assigning your successor a year in advance of your scheduled departure date. If you have a strong management team in place, you should try to implement employment contracts, non-competes, and some form of phantom stock or equity participation plan to keep these stars involved through the transition.


3. Contractually Recurring Revenue – All revenue dollars are not created equal. Revenue dollars from a contract for annual maintenance, annual licensing fees, a recurring retainer fee, technology license, etc. are much more powerful value drivers than projected sales revenue, time and materials revenue, or other non-recurring revenue streams.


4. Proprietary Products/Technology – This is the area where the valuation rules do not necessarily apply. If strategic acquirers believe that a new technology can be acquired and integrated with their superior distribution channel, they may value your company on a post acquisition performance basis. The marketplace rewards effective innovation and yawns at commodity type products or services. Continue to look for ways to innovate in all facets of your business. If you create a technology advantage in your company, think what that could mean to a much larger company.


5. Penetration of Barriers to Entry – In its simplest form, a large restaurant chain buys a small family owned restaurant to acquire a grand fathered liquor license. Owning hard to get permits, zoning, licenses, or regulatory approvals can be worth a great deal to the right buyer. The government market is extremely difficult to penetrate. If your product or service applies and you can break through the barriers, you become a more attractive acquisition candidate.


6. Effective Use of Professionals – Reviewed or audited financials by a reputable CPA firm cast a positive halo on your business while at the same time reduce the buyer’s perception of risk. A good outside attorney reduces the risk even more. A strong professional team is a great asset in growing your business and in helping you obtain maximum value when you exit.


7. Product/Sales Pipeline – Smaller companies often are more agile and have better R&D efficiency than their high overhead big brothers. In technology, time to market is critical and big companies evaluate the build versus buy question. Small companies that develop new technology are faced with the decision of developing distribution internally or selling to a larger company with developed channels. A win/win scenario is to sell out at a price, in cash and stock at closing, that rewards the smaller company for what they have today, plus an earn out component tied to product revenues with the new company.


8. Product Diversity – A smaller company that has a quality portfolio of products but may lack distribution can become a valuable asset in the hands of the strategic buyer. A narrow product set, however, increases risk and drives down value.


9. Industry Expertise and Exposure – Encourage your staff to publish articles and to speak at industry events. Encourage local and industry reporters to use you as the voice of authority for industry issues. Your company is viewed in a more positive light, gets more business referrals, and an industry buyer will remember you favorably as an acquisition candidate.


10. Written Growth Plan – Capture the opportunities available to your company in a two to five page written growth plan. What additional markets could we pursue? What additional products could we deliver to our same customers? What segments of our current market offer the most growth potential? Where are the best margins in our customer base and product set? Can we expand in those areas? Can we repurpose our products for different markets? Can we license our intellectual property? What about strategic alliances or cross marketing agreements? Documenting these opportunities can add to the purchase price.


When it comes to unlocking the market value of your privately held company, it is not limited to the bottom line. Profitability is hugely important, but the factors above can result in significant premiums over traditional valuation approaches. When you sell Microsoft stock, there is no room for interpretation about the market price. The market for privately held businesses is imprecise and illiquid. There is plenty of room for interpretation and the result for the best interpretation by the marketplace is a big pay off when you decide to sell.


Why Exit Planning is Important

June 20, 2011

“After all is said and done, a hell of a lot more is said than done.” Olmstead’s Law (Jester’s Condescending Dictionary)

At some point in time every business owner will “exit” their business.  In most cases, a small business represents a significant part of family wealth and the owner will be keenly interested in maximizing this value when the business is either sold to an outside 3rd party or key employee, or transferred through an orderly succession to a family member.  Unfortunately, most entrepreneurs are so immersed in the daily demands imposed in operating their company that they have neglected to properly plan for the inevitable transition of their business.   The goal of this article is to briefly review the exit/succession planning process and highlight the importance that these plans have for every business owner.  Whether the goal is to exit the business in six months or ten years, it is critical that a business owner recognize that succession planning is the single most important way to take control of the terms and conditions of exiting their business. Proper exit planning will cut the variability of the business control transfer, and can secure a sound financial future for their family. 

What is Exit Planning?

Exit Planning, also commonly called “business succession planning,” is a method that addresses three critical questions a business owner will face at some point:

  1. What is the timetable the owner seeks to exit the business?
  1. Who will succeed the owner when the business is transitioned or sold?
  1. How much income is needed from the business transition/sale for retirement?

The Exit Plan becomes a written roadmap that is developed in conjunction with legal, accounting, and financial professionals and is designed to maximize the value an owner receives when exiting the business.  Exit planning can be a fairly complex long-term process and take many years to properly carry out. The process can be broken down into simple action items and deliverables and should illustrate how value can be received at a very early stage.  A professional team will bring efficiency to the process by implementing a basic structure of steps to be followed, and can make sure that the experience will be a personally gratifying and financially rewarding endeavor for the owner.

The key steps involved in developing an Exit Plan include:

  1. Establishing Exit Objectives:  Determining the retirement timetable, long-term income needs, and financial requirements necessary to reach them.
  1. Identify the key drivers of business value:  What is the fair market value of the business if it were sold today?
  1. Plan to build & keep business value and reduce risks:  Activities that can be implemented to leverage best practices and maximize the business value.
  1. Transfer of ownership, management, & control:  Determine the anticipated buyer (outside 3rd party, key employee, family member) and develop the structure for ownership transfer that maximizes financial security while minimizing taxes. 
  1. Contingency Planning:  Protect the continuity of business operations should an unexpected event occur.
  1. Wealth management/preservation:  Secure financial independence by developing a financial plan to manage the income from the business sale. 
  1. Successful Exit

While nearly all business owners will recognize the importance of having a formalized exit and succession strategy for their future and the future of their company, very few actually have a plan in place.  What most business owners fail to recognize is that the process is fairly easy to start and can be done at a minimal cost.  While many components of the Exit Planning process will need the ability of a CPA, Attorney, and Wealth Manager, significant value and efficiency could be achieved by implementing this process through a competent Business Intermediary/Brokerage firm. An experienced business intermediary firm will be able to streamline the exit planning process significantly by taking the lead in the planning framework and tapping the necessary resources (accounting, law, wealth management) over time as they are required. This team concept is very cost-effective for the business owner as he is only paying for the specific services at the time of use.  A business owner is now able to put a toe in the water and set up the framework for the exit plan at very little cost. By establishing the current market value of the business with a determination of the owner’s exit timetable and the income needed for retirement, the Business Intermediary will have the essential elements for the foundation of the Exit Plan.

Implementation should be viewed as a process versus a one-time event, and the most successful and rewarding Exit Plans are those that are started years in advance of the business transition.  Whether the planned exit is six months or ten years from now, an owner should be proactive. The longer that a business owner has to carry out the Exit Plan, the greater the opportunities will be to maximize the business value, reduce tax liabilities, avoid key employee turnover, and end emotionally charged family issues.

Business Value Drivers

March 14, 2011

“Business is a good game, lots of competition and a minimum of rules. You keep score with money.” — Nolan Bushnell

Today’s business environment is not just about survival, it’s about focusing on and creating sustainable value. But, which elements of a business are capable of creating value? Equally important which elements of a business are capable of destroying value? Proper business planning is the process of uncovering and identifying what creates and drives value. 

Start by using the SWOT Analysis – Strengths, Weaknesses, Opportunities and Threats – this will help you name the “value drivers” for your business. With this approach, you can focus on key value drivers.

There are many Value Drivers that have been identified in businesses. But, typically no more than 8-12 are critical in any given business; here are the most common 8.

 Financial History:  Are your books correct and up to date? Over the last few years are there patterns of growth or decline? If in decline, are there good reasons for the decline?  Accurate and current financials are important to decide how the company fares in its industry and among competitors.  A comparison to industry ratios can find strengths and weaknesses in the business.

 Management Depth: Can the company run without the owner, for more than a week or two? Is there any cross-trained management to fill in if you were gone?  What is the average age of management?  Will they retire soon? What levels of experience and education do they have? Having a good management team can add value to the business.

 Customer Diversity: Do you have one or two major customers that account for more than 25% of your gross sales?  What would happen to the value of your company if you lost one? Are most of your customers considered “blue chip”? A good overview and a rating analysis of the customer base can be beneficial not only for added value but is crucial for where, how and when you advertise, not to mention a better understanding of your accounts receivable and aging. 

 Owner Involvement: Are you the ‘rainmaker’ in the business? Does everything from sales to production revolve around you and your decisions? How difficult would you be to replace? The more the business depends on you, the owner, the more likely the value will be lowered.  One of the things I see the most is that over the years, the business owner and number one sales person is now an office manager.  Maybe it’s time to get back out in the field with your sales people or give ongoing sales training.

 Competition: Does your company compete in a clearly defined market niche which is defensible? Or, have your products or services become a commodity that is becoming more difficult to defend?

 Customer Satisfaction:  Are your customer relationships based on great products and service, or lowest price? How long and what type of history have they had with you? Are they satisfied or loyal? Do you have systems in place to show your customers and communicate?

 Loyal Employees: Outside of ownership, are there people in place who you can rely on and are capable of doing their job day in and day out? Are they considered knowledgeable for your industry? Again, what levels of experience and education do they have?

 What is the average length of employment among your staff? A responsible business buyer will be looking for opportunities where the current staff, especially management, will stay in place, after the current owner’s exit from the business. Having key employee contracts, non-competes, but more importantly a loyal, dedicated staff that is committed to the company’s success regardless of ownership change will be highly valuable to a prospective buyer and thus reflected in a business valuation.

 Proprietary Technology: Has your company developed a unique application, tool or technology as part of its ongoing operations? Does it give you a competitive advantage? If so, this proprietary innovation or intellectual property can be positioned as a key value driver for your business. Technologies or processes do not have to be patented to carry value but privacy and confidentiality must be maintained. It is critical that non-compete and confidentiality agreements be strictly adhered to and enforced by the company, before and after a transfer of ownership. The benefits, application and purpose of your proprietary technology should be explained to a business valuation consultant.

Intangibles (intellectual property) and human resources (who go home at night) can be protected and leveraged through a combination of business strategies and legal protections. Business strategies include incentive compensation plans to recognize, reward and keep high performing employees. Legal protections include requiring key employees to sign non-compete agreements, registering Trademarks and Copyrights, and taking steps to protect proprietary information/trade secrets such as recipes and formulas. Contracts with key players, including partners, customers and suppliers, are also important.

In conclusion, it’s easy to be distracted by all the demands competing for the business owner’s time and attention. To maximize the value and profitability of your company, you need to focus on the key value drivers – which may be intangibles and employees – as well as having up-to-date equipment and systems.

Adding Value to Your Business

February 26, 2011

“Though no one can go back and make a brand new start, anyone can start from now and make a brand new ending.”–Carl Bard

If you’re looking to sell a business, it’s critical to look at the value of the business.  But a typical business really has two values.  The “academic” value is the one determined by a professional business valuation.  The other is the “true market” value.  The academic value is arrived at with a formula based on the firms’ hard assets, cash flow, industry averages and multiples.  The fair market value also takes those items into consideration, but then considers what buyers are really willing to pay.

For many small and mid-sized businesses hard assets like equipment, vehicles, land, buildings, and inventory may be limited.  For some small businesses there may be no hard assets at all.  Instead, their value is based on intangibles like employees, business processes, customer lists, location and business relationships. 

To maximize the fair market value of your business, it’s vital that you capitalize on those intangible assets. 

Develop key employees.  Buyers generally aren’t interested in paying a premium if the business relies on you for its success.  Remember to delegate responsibility to key employees and involve your key staff members in the decision-making process.  Demonstrating that your company’s success is reliant on your capable, well-trained employees – not just you – will pay off at the time of sale. 

Document what you do.  Be sure that job descriptions, operation processes, and strategic plans are documented.  Documented records and plans give a buyer greater comfort that he or she will be able to emulate your successful growth and will help your buyer get financing.  Also, be sure to keep business records like sales and expense reports, internal profit and loss statements/balance sheet, and tax returns clean and well-organized. 

Build relationships.  Name recognition, customer awareness and your reputation are all part of your business value.  Even if your company doesn’t have many hard assets, your relationships are key.  Consider diversifying both supplier and customer accounts. 

Improve cash flows.  A potential buyer wants to see the “true cash flow.”  And, of course, in the business world cash is king.  Be sure you are driving all income to the bottom line. 

Review your assets.  Sell off or dispose of unproductive assets or unsalable inventory.  Remove or buy off any assets that are primarily for your personal use. 

Find and build your niche.  You don’t have to be everything to everyone.  Buyers will pay a premium for a niche that has barriers to competitive entry. 

Remodel, clean, and organize.  What’s the first thing anyone does when they put their home on the market?  They spruce things up and make sure everything is in its right place.  Yet, in business, that’s rarely considered.  A well-maintained facility will get the best price.  Even businesses that lease space can benefit from a thorough cleaning and organization to convey a feeling of quality and efficiency. 

Keep these important intangible assets in mind if you’re looking to sell your business.  They convey a value that financial statements alone do not.  If you are looking to sell, make a plan.  Start working on the intangibles well in advance of putting your business on the market.  For many business owners, they reach a point where they burn out and psychologically retire early, before a sale is made.  It’s important to work to keep your focus right until the sale is complete. 

Finally, when the time to put your business on the market arrives, consider lining up key specialists who will help you make the most of the sale – an attorney, an accountant, and a business intermediary to name a few.  Remember, you only have one chance to sell your business, so you want to do it right.