As an expert in wealth building and business management, I often consult with owners who are preparing to sell their businesses. We work together to identify areas of improvement that will ensure the best selling price in the market. My outsider perspective, high-level focus, and unique ideas all work to cut through the resistance that all too often prevents otherwise intelligent business owners from realizing maximum value on the company they’ve spent so much time and energy building. I make sure this transition really pays off.
These consulting engagements have a very simple purpose: to increase the value of the business. Increasing cash flow to the owner and increasing enterprise value are the two primary ways to increase the business’ value. Of course, increasing cash flow to the owner also typically increases enterprise value.
Each engagement is defined as a quick or a long engagement. The process is the same either way, but in a long engagement, we might spend months or years going over every item, focusing on just one item at a time to produce maximum value.
Since the value of the company is most commonly calculated as a multiple of cash flow, we’ll spend much of our time focused on increasing the amount of cash available to the owners, which increases the amount of value received by the owner when selling.
There can also be significant strategic value extracted when negotiating the multiple upon which the selling price is calculated. The multiple is based almost entirely on soft factors or intangibles. Most owners ignore the effect these items have on their business and leave money on the table. Improving operations, culture, and general competitiveness, while not increasing the bottom line, can increase this multiple, thus bringing significant amounts of cash to the owner during a sale.
Is the business a good fit?
The first step in a consulting engagement is to determine if your business is a good candidate for a sale. Not all businesses are. We also spend some time learning what factors are present that might detract from or increase the value of your business.
Three items drive the value of your business: profit, growth, and risk. The first two increase and the third decreases the value. Before discussing these items, there are a couple assumptions we make for our overview and initial conversation:
- We assume that we are selling 100% of the company and not taking minority, partial, or restricted sales into account.
- We are ignoring “strategic” acquisition opportunities. We assume that all value has to come from the business being sold and not its value after being combined with another business.
- We are assuming these are “arm’s-length” transactions of privately- or closely-held companies.
- We are agnostic to the various valuation models (income versus market approach) and assume that increasing profit or growth increases value and decreasing risk factors increases value in all cases.
- Finally, a comparison of the subject firm’s numbers to peers is appropriate.
Areas of the Business to Review
After determining that a business is a good candidate for a sale, we collect a large amount of data that we then analyze, looking for opportunities for improvement. Below are the areas we look into and some details about the type of information we’ll need and why it’s important.
A discussion and analysis of financial trends is first. We track two to three years of changes in:
- gross sales
- gross margin (where applicable)
- net margin or cash flow (as appropriate)
We also look at the leverage in the company. There are two types of leverage to consider: operational and financial. With operational leverage we are looking at the overhead structure of the firm. How easy is it to scale expenses up and down with changes in revenue? We attempt to determine minimum operating levels and the cost of growth.
When looking at financial leverage we examine the past growth or decline of debt levels and consider what the optimal capital structure might be, based on consistency of cash flows, levels of fixed assets required, and credit worthiness.
Leverage will be intertwined with the customer analysis, looking at the company’s leverage risks as they pertain to customer or sales concentrations and asset needs.
Sales & Customers
A variety of items need to be looked at as they pertain to sales and customers. Almost all the analysis of sales and customers revolves around the risks of losing business. An analysis of customer concentration is always important to understand the risk exposure of a single customer or group of customers leaving. For example, high operational leverage combined with a large customer concentration can be a highly risky business. But many other factors can also come into play:
- presence of sales contracts
- switching costs
- length of relationships
We will also look at customers from a growth opportunity standpoint when analyzing the company’s growth and opportunities.
Analyzing strategic factors can be both the most difficult to do and the most rewarding. It is here where significant values can be created by demonstrating to a buyer ways in which they could grow the business. We look at factors that include the market a business operates in, the channels through which it sells, and the effect that current market share has on the company.
Costs & Vendors
A brief review of the risk and opportunities involved in the purchasing side of the equation will involve reviewing vendor contracts, concentration, and how the lead times and purchasing requirements affect the way the business operates.
While most companies do not have significant value attached to their fixed assets, reviewing those assets can add significant value to the business. A buyer will also want to understand the schedule of capital investments that have been made and will need to be made. Aging and old equipment can be a detractor from value.
Intellectual property is a popular way to try to assign more value to a company. Our analysis will challenge the often over-valuation of ideas and goodwill. How well protected an idea is, how executable it is, and the ease of substitution all need to be looked at before trying to determine a value.
Operational issues tend to be the most neglected area of a business. Many businesses grow out of smaller operations and their workflows have not kept pace. Or worse, the way in which people work has been completely ignored. A business that relies heavily on the owner destroys significant value for the buyer. A variety of areas need to be documented and understood:
- the workflows of the company, including how people do their jobs
- the internal controls that empower employees while protecting the company from fraud
- staffing issues, including turnover, training, and efficiency
- management issues, including non-competes and the experience, skills, and ability of the company to continue in the same manner after a sale
- the information technology supporting the business and its investment and maintenance requirements
- the culture of the company and its effect on the operations and growth opportunities
Growth & Opportunities
As with strategic analysis, this can be a significant source of value. Just a few of the ideas that we have seen add value include:
- Customer saturation: What is the opportunity to increase the size of each relationship?
- Operational improvement: Where are the demonstrable increases to margin that can be realized?
- Market opportunities: What complementary markets can our products or services be expanded into?
We collect all of this data, looking into each detail as it relates to increasing cash flow or improving the often-overlooked factors that can increase the multiple used to calculate your business’ selling price. The next step, which I’ll cover in an upcoming post, is to formulate a strategy that deals with four overarching areas within a successful business: strategy, operations, revenue, and culture.
Business is simple, but it’s easy to forget that when you’re caught up running one. I’m here to remind you of that and to cast a light on the details you’ve overlooked by being so close to the action. I’ll help you overcome your resistance.