Achieving the maximum value for the business when it sells is the goal of every business owner.
A business has value when it can exist separately and apart from its owners, when it has taken on a structure and culture of its own, or where there are processes, methods, products, property rights or anything else that allows the business to continue as its own entity.
These ten ideas can help you determine if you are on the right track:
1. Develop a strong, stable management team
A business with a strong management team, allowing for key activities to operate independent of the owner, will command a higher price. The depth and stability of the management team are extremely important factors in the valuation analysis by a buyer. In many businesses, sales and marketing may be very dependent upon the owner, and this can be a significant value detractor. If most of the key account relationships reside with the owner, buyers will factor this risk into the valuation or the deal structure. Part of the price may become contingent upon the owner remaining with the business to maintain continuing customer relationships.
2. Demonstrate sustainability of earnings
Revenue and earnings that have been steadily growing over several years, versus earnings that fluctuate dramatically, will drive a higher valuation. Year over year growth demonstrates a solid operation that is gaining new customers and/or market share. Dramatic fluctuations in revenue typically indicate that either product demand may be subject to outside factors, or the business has experienced problems, indicating management is not stable. It makes sense to have a written plan describing future growth and how that growth will be achieved based on industry dynamics, increased demand for the company’s products, new product lines, market plans, growth through acquisition, and expansion through augmenting territory, product lines, manufacturing capacity, etc.
3. Develop systems and procedures
A business must exist separate and apart from the daily actions of its owner to have a valuation, including goodwill, over and above the asset valuation. An owner who takes a week off at least one or two times per year, is exhibiting confidence in the systems and procedures of the business to function while they are away. If the owner is seldom or never away from the business for any length of time, buyers will question the strength of the operating systems, and the management team. The amount of goodwill that a buyer is willing to include in the purchase price will be dependent upon systems and procedures.
4. Maintain excellent financial records
Sloppy financials are a worry for both buyers and lenders. Valuation will be based primarily upon the numbers and the more reliable the financial statements, the more chance they will hold up in due diligence. If your business has revenue in excess of $10,000,000, audited financials will be worth the investment. In the absence of audited financials, reviewed financials are preferable over internal financials, as the presentation, account classifications, footnotes, and organization of the statements, in general, will be much more professional than internally prepared financials.
5. Minimize personal expenses paid by the business
When the financials are “clean,” with very few “add backs” related to owner’s personal expenses paid through the business, buyers and lenders believe the numbers are more credible. Asking a buyer to believe that various expenses that have been paid by the company are in fact “not necessary” for the business creates uncertainty. Uncertainty is the enemy of a successful sale transaction. When the EBITDA computation is partially based on excessive “add backs” to earnings, the seller will be hard pressed to obtain a favorable valuation.
6. Transition Planning
When a seller has a definite plan to “phase out” of the operation, whether that is over one year, or three to five years, the buyer recognizes that sound planning has occurred. The process of developing this transition plan will often generate excellent suggestions for improvement in management’s role in the everyday operations of the business. Many sellers begin to outline their “job description” as part of this process, which highlights areas where there is a need to delegate more to the management team. Quite often this activity will result in improvements to the organization structure of the business and produce tangible benefits.
7. Diversified Customer Base
Customer concentration is a significant value detractor. When the revenue from any one customer accounts for over 20-25% of the total revenue of the business, the business will be valued at a discount. Losing 20-25% of revenue in most businesses will typically wipe out most or all of the profit of the operation, so this risk may not be ignored. When the buyer’s valuation is prepared, and this risk is factored into the valuation analysis, the goodwill included in the valuation of the business will be dramatically altered. Working to diversify the customer base will result in significant increases in the value of the business.
8. Solid Reputation in the Marketplace
Business acquirers are constantly searching for the leading business in the industry and many sellers refer to their business as an “industry leader”. Savvy buyers can mine the internet for information about what customers actually think about most businesses. It is very easy for buyers to access multiple websites that give “feedback” from customers about businesses; buyers will attend trade shows, industry conferences, and multiple other events, quietly asking competitors and suppliers about a company, using multiple techniques to determine what customers think about a business.
9. Diversified Base of Suppliers
A very narrow base of suppliers, or extreme dependence upon one supplier, may cause a decrease in valuation. Many business owners routinely buy from multiple sources; just to manage the risk that one supplier may experience shortages or interruptions in supply. This extends to the labor pool as well, if the business needs specialized skills, such as in healthcare. “What happens if…” is a typical question a buyer may ask – and many sellers do not have a ready answer for that question.
10. Stable Facility of Operations
A business may or may not be dependent upon its location, but a buyer will not want to take the risk of moving the business right after the purchase. The business should have the right to remain in their current facility for at least 3 – 5 years through an existing lease, or ownership of the building. The location may be critical to a retail operation or restaurant, but also important to a wholesale or manufacturing operation. Many times key employees live close by, and the buyer having to relocate the business may place loyal employees in peril. If the lease is about to expire, and the buyer will have to renegotiate the lease right after closing, this situation creates uncertainty, which reduces the valuation. Lease options are an excellent method to remove this uncertainty, whereby the business has the right, but not the obligation to extend their lease beyond the current term.