15 Feb Preparing the Business for Maximum Sale Value
How a business is sold has as much to do with the value received (i.e., Sale Value) as the characteristics of the business itself, but the business— and its compilation of characteristics— is the foundation. Remember the Sale Value© equation:
Sale Value = Enterprise Value + Packaging + Process + Deal-Maker Skill©
The innate value of the business is referred to as the Enterprise Value. But the actual value received is referred to as the Sale Value. Virtually every business owner wishes to sell someday for big bucks. And when it comes to money, more is always better, so business owners should endeavor to continually grow the value of their enterprise (i.e., the Enterprise Value of their business). They should do so, of course, well before they take steps toward actually selling. For that, here are the things that drive Enterprise Value:
Profit/High Profit Margins: Buyers buy businesses for the money they can earn from owning them. The higher the established profit, the more the buyer can and will pay. Profit margins are important as well. Are they higher than the industry averages? Gross and operating profit margins that consistently exceed industry averages will command higher values.
Growth: Revenue and profit growth is the #1 driver of value. Establish a pattern of growth and you will establish a substantial premium for your business. Of importance as well is rate of growth relative to that of the overall economy and, more particularly, the industry the company participates in.
Customer Quality and Diversity: Diversification of customers and customer tenure, loyalty and credit-worthiness are all important when valuing a business. What would the impact on the company be if the largest customer were lost? If the answer is very little, then the company has virtually no customer concentration risk and, therefore, a higher value. If the answer is substantial, buyers won’t want to bear that risk without being handsomely compensated for doing so. Generally, if a company does not have a customer that accounts for 10% or more of revenue or profit, there is little concentration risk.
Management Quality and Depth: Buyers are justifiably interested in the likelihood that the established profit stream will be able to be continued after they purchase. To the extent the business has a diverse group of top managers and employees that will remain, the buyer gains confidence. As a result, the buyer will be willing to pay more for the business. Management depth, quality, tenure, experience, track record and education are all important considerations.
Industry Growth: Industry health and growth make it easier for a company to grow revenue and profits. Equally as important is that the competition tends to be less fierce in expanding industries. The more attractive the industry or industries, the higher the enterprise value.
Multiple Industries: If the product or service offerings of a company are sold into multiple industries, a higher value is justified. The business can grow to twice the size (assuming each industry niche is of equal size) and enjoy meaningful industry diversification. For example, a maker of titanium tubing has traditionally sold to industrial customers but has recently successfully penetrated the sports equipment marketplace. This business will command higher values.
Proprietary Products: The more proprietary the nature of the products or services, the higher the value. In other words, is what you offer unique to anything offered by anyone else? Unique, of course, in a way that is meaningful or valuable to a certain customer group or groups? For example, a non-exclusive distributor of a product enjoys little differentiation or protection from pricing pressure from its competitors, whereas a manufacturer of a proprietary line of products should enjoy a more defensible market position, thus higher profits.
Product Mix and Diversification of Gross Profit: The greater the number of products and services the company sells and the greater the diversity of revenue sources, the lower the inherent risk of the business. Businesses with a healthy product mix and good gross profit diversification deserve and earn higher valuation multiples.
Market Niche, Market Position, Brand Awareness: If a company fills a definable niche, commands a special leadership position in a niche or niches, or enjoys favorable brand recognition in its industry, the business probably enjoys higher profit and growth rates. It should also be easier to grow the business in the future. As such, buyers will pay more.
Low Debt: While debt is not really a value driver, it substantially affects the net-cash received by the seller. When a business is sold, the seller basically sells the net equity of the business. Whether the sale is effected by a sale of the business’ assets or shares of stock, something must be done with the debt of the business. If the buyer assumes the debt, he or she will do so as a form payment to you, lowering the cash you get at closing. Further, in an asset sale you’ll owe federal and state taxes on the amount of debt assumed by the buyer. If the buyer does not assume the debt, the seller will have to pay off the borrowing with after-tax dollars.
Interim Results: Buyers are interested in what the business will do in the future. The most tangible indicator is the past, with an emphasis on near-term trends. Strong current performance can justify higher prices, and a dip in performance will certainly hinder value (if not turn away the buyer entirely).
Minimal Off-Balance-Sheet Liabilities/Contingent Risks: Risk and uncertainty lower values. If elements such as the following exist, correct them, wait for the issue to subside before attempting to sell your business, or be prepared to indemnify (i.e., protect) the buyer post-closing, in a real and meaningful way, from any financial loss the buyer may suffer from them post-closing:
- Existing or pending litigation (of a material nature)
- Real or possible environmental liability (of a material nature)
- Lease or other “right to use” problems or uncertainties
- Significant acute industry or market uncertainty
- Customer concentration
Low Future Capital Expenditure Requirements: For the business to earn the profits projected by the buyer, or to continue to expand, how much money must be spent? Can the existing assets and staff handle the production requirements for the foreseeable future or will new dollars have to be spent to replace, expand or— worst case— relocate? Future capital expenditure needs will have to come out of future profits, thereby lowering the value of the business.
Organized, Detailed and Credible Financial Information: Financial statements present the financial condition and performance of a company. To the extent that a buyer feels certain your reports are accurate and may be relied on, his or her perceived risk will be lower— especially when it comes to income statement recastings. So keep detailed and accurate books and records (especially with respect to recast items) that will garner comfort and confidence. But audited statements are not necessary and not worth the expense for small and midsize companies.
Clean, Organized, Safe and Pleasant Appearance: Does the business “show well?” Is it attractive in appearance? Is the facility clean, painted and bright? Does the office appear clean and organized or cluttered and unprofessional? Are the logo, marketing materials and website up to date, and do they convey a positive, vibrant image? Just as a clean and waxed car sells for more, so will a business.
A Growth Plan: Buyers are interested in the future. Lay out a path for significant future growth and profit and —to the extent the buyer believes he can make it happen— he might be willing to pay more. At times, much more.
No business will have all of these in spades, of course, but the business owner who wishes to build the value of his or her enterprise (i.e., Enterprise Value) should work to build these elements as best he/she can, and mitigate the most glaring weaknesses. Packaging, Process and Dealmaker Skill greatly impact Sale Value, but Enterprise Value is the anchor.
How do we know? We sell business for a living. We’ve worked with thousands of buyers on hundreds of deals. We know what buyers want and what influences the price they pay. Now you do, too.