NO PLAN TO MAXIMIZE VALUE
Once you’ve built a business that is sellable, your next challenge is to measurably increase its value.
A business owner had a sellable company in a stable industry, and a good financial plan for his exit. His plan was to move to Arizona where he wanted a million dollars to build and furnish a new house on a lot he already owned (net after selling his current house), $2 million to payoff business and personal debts, half a million dollars for a travel fund, and $15,000 each month (after tax) for everyday living expenses. His financial advisor recommended a $7.5 million annuity to provide the monthly income and said that, all together, proceeds from selling the business had to total $11 million. The business owner wanted to what to do to make his company worth that much.
In his industry, price multiples were 0.6 to 0.8 times revenue and five to seven times EBITDA, which is a measure of pre-tax cash flow. From a buyer’s perspective, more cash flow means a higher value. So his business had to generate $14 to $18 million in annual revenue and produce an EBITDA of $1.6 to $2.2 million depending on whether the buyer valued the company at the low or high end of the multiple range. He already had a plan to increase revenue and EBITDA. But how could he position his company to be at the high end of the multiple range?
We evaluated the company against 17 factors (see the Appendix) that determine value for buyers of similar sized firms in his industry. It rated above-market in four factors and equal-to-market in ten. The three below-market factors were:
(1) Management Team: The senior managers lacked depth and didn’t grasp the company’s strategic priorities. Since he planned to leave the company after closing, a strong management team was vital.
(2) Business Pipeline: His business had a history of winning renewal contracts, but no reliable process to manage new opportunities and accurately predict contract signings and future revenue.
(3) Budgeting: The business had no annual budget, profits were low, and Days Sales Outstanding (DSO) were high because of erratic billing practices and receivables follow-up.
It took 20 months to develop and implement the action plan to improve these three areas - then he hired a broker to market the company. Six months later, he closed the sale for 0.83 times revenue and walked away with almost a million dollars more cash than his financial target, which was fortunate because the stock market tanked and his annuity returned less than expected.
Looking at your business through the eyes of a buyer will pay huge dividends. How do its growth rate, pipeline, profits, and financial ratios compare to other companies in the same industry? What areas are weak relative your competitors, and how can you neutralize or eliminate those weaknesses? What are your strong points, and how can you showcase them in your branding and go-to-market strategies? Buyers especially trust what they learn about your business before they meet with you and hear your obviously biased description of the company.
Since buyers evaluate future earnings potential based on prior years’ earnings, you will usually get the highest price when your company is approaching a peak in its earnings curve. Your position on that curve is determined by both external and internal factors. The external factors are related to market conditions and the economy which, in general, you cannot change.
On the other hand, you have full control over internal investments that push your company toward peak revenue and profits given your current resources. Most businesses reach a size plateau where they can only grow further by investing in a risky and expensive expansion. If you have a services business, you may need to diversify its offerings, penetrate new clients, or expand into new geographic markets. If your company produces products, you may need to open a new facility, buy additional equipment, hire more sales staff or employees, or invest in a new technology. It’s ideal if you can time your sale to occur just before the approach of a revenue peak, and manage your growth strategy and process improvements toward achieving that peak.
In maximizing the value of your company, consider three different types of outside buyers:
A strategic buyer is a company that is in a line-of-business similar to yours. Their objective in buying your company is to expand their customer base, capabilities, competitiveness, or offerings.
A financial buyer’s goal is to earn a fair return on the investment, liquidate the acquisition loan from cash flow, build equity for a future sale – all while someone else runs the day-to-day business.
A lifestyle buyer is looking to buy your company because it will provide a rewarding work experience and deliver an acceptable salary and benefits to the new owner.
Each of the three buyers has a different way of determining how much they will pay for your business, but the actions you take to maximize your company’s value will be viewed positively by all of them.
Failing to take timely action to increase the value of your company can be an expensive oversight. We often see business owners stuck in the quicksand of day-to-day operations. They forget that the company is their most valuable asset and, when a buyer comes along, they are left with I-meant-to-do-it fixes that reduce the selling price. Few business owners realize that it takes about two years to prepare a company to be sold. When M&A markets are in a dormant state, it is an ideal time to begin shaping your business to maximize its value and be ready for the boom market when it returns.