Posted by Tom Gledhill on Fri, Sep 04, 2009 @ 09:32 AM
When a strategic or financial buyer invests in a company, they are in essence investing in a stream of future cash flows. At the end of that stream of cash flows comes the "terminal value" - the last big cash flow from their eventual exit event. Naturally buyers will want to minimize the risk that they won't receive those future cash flows. The more you can reduce a potential buyer's risk, the greater your company will be worth. So what can you do in your company to reduce that risk? What could potentially happen that could negatively impact profitability and what can you do to mitigate that risk? Here are a few things you can do:
1) Diversify your customer base. Having more than 25% or so of revenue coming from a single customer is a big risk.
2) Separate yourself from the company as much as possible. Easier said than done especially for small companies - but the less integral the owner is to the operations of the company the lower the risk to a new owner.
3) Groom management and offer key employees "stay bonuses" so they are incentivized to stay with the new ownership.
4) Contracts with key suppliers and customers can ensure that those relationships transfer to successor ownership.
5) Manage your assets. Make those necessary ongoing "maintenance" capital expenditures so that your equipment isn't out of date and in need of replacement ahead of schedule.
6) Financial statement accuracy. Ensure that your accounting system is up to date and have financial statements prepared annually by your accountant. Reviewed statements are better than compiled - and some buyers may even require audited statements. They may cost more but the perceived reduction to risk in the eyes of the buyer will almost certainly increase the value of your business enough to more than cover the cost of the audit.
These are just a few of the many ways you can reduce risk in your business. The more you can focus on risk reduction the more your business will be worth.
Posted by Tom Gledhill on Thu, Sep 03, 2009 @ 02:42 PM
Every business sooner or later will be sold or transferred to someone else. Whether that someone else is an insider (e.g., a family member or key employee) or an outsider, certain steps can be taken to ensure that the transfer achieves the goals of the business owner. This process is known as exit planning. Unfortunately, the majority of business owners do not take the proper steps to maximize the proceeds they'd receive upon the sale of their company and/or achieve their overall objectives.
Set goals for yourself
You may have put together a business plan when you started or acquired your business, but how often have you updated it? I'd recommend that you annually sit down and reevaluate your strategic plan for yourself and your business. Project the business three to five years into the future. Will you be entering new markets or introducing new products?
Also, how do you see yourself transitioning out of the business? Will you sell to a third party or keep the business in the family? Do you plan to retire upon exit or will you be starting a new career or buying another business?
Assemble a solid team
There are numerous professionals involved in successful exit planning, many of whom are probably your current advisers. Your team should include: attorney; accountant; wealth adviser; mergers and acquisition adviser/business broker; insurance professional; and any other trusted advisers. Each of these professionals brings vital skills to the table.
Watch your expenditures
Be careful where you spend your cash. Clean up your income statement and eliminate unnecessary expenses. The most likely valuation of a profitable company involves the capitalization of a company's cash flow; so every dollar saved on your P&L equates to two to four dollars of value in your company.
Also, make sure that you earn a good return on investment on capital expenditures. Put yourself in the potential buyer's shoes - what about your company is valuable? Make sure the capital and time you invest in the company enhances that value.
Make sure your information systems are up to date
Owners and managers should have systems in place so that information received is timely and accurate. These systems need to be transferable to the buyer. While a spreadsheet of financial data may work for the owner, would a new owner be able to understand it? Bookkeeping should be performed using standard accounting software such as QuickBooks. The same goes for any other system in the business - if the industry standard is to have certain software to handle inventory or project management, then the company should have that software in place.
Management and/or trained employees in place
A business is difficult to sell if the owner is too embedded in it. A buyer will want to be able to step into the business and take over from as close to Day 1 as possible. (Often sellers stay on for a finite transition period after the sale.) Talk to members of your exit planning team regarding creative ways to create incentives for key employees to stay.
Manage the relationships with customers and suppliers
Your goal in selling to an outside party is to minimize the perceived risk of buying your company. A key component to this is customer diversification. If any one customer comprises greater than half of your revenue, you're at risk of that customer leaving and inflicting a potentially mortal blow to your business. The same risk exists if any one supplier of a key material or service has too much power.
Perform pre-transaction due diligence
Review with your advisers all of the items a potential buyer would want to review, including contracts, leases, equipment lists, etc. Additionally, you'll want to ensure that you have up-to-date financial statements from the last three to five years available, prepared by your CPA. It may make sense to pay for more in-depth financial statements such as reviews or even audits if your company is large enough. Lastly, make sure that these items, as well as any potential "skeletons in the closet" are documented and presented to the buyer. Obviously, if the skeletons can be removed then do so, but definitely make sure that a buyer isn't surprised. That could kill the deal.
These are certainly not the only things you can do to ensure a smooth exit plan. Most of all, heed the advice to hire professionals to assist you. With the right help, you greatly improve the odds of achieving your goals!
Posted by Tom Gledhill on Tue, Sep 01, 2009 @ 07:00 PM
In a survey conducted by a Midwestern university several hundred business owners were asked "What are your plans for business succession - to pass the company on to your children/key employees or sell to a third party?" Seventy percent (70%) responded that they planned to pass the business on to children/key employees and 30% responded that they would sell to a third party. Several years later these same business owners were contacted. Of those that transferred ownership, about 30% passed the business on to children/key employees and about 70% sold to a third party. The reality was that the vast majority sold to a third party even though their original intent was to pass it on to children/key employees. There are several reasons for this - the major reason being that it creates the biggest payday.
So now you plan to sell to a third party in 2-3 years. What are you going to do after you sell your business? Will the proceeds from the business support that? Do you know the type of buyers that may be interested in acquiring your company and what they're looking for? Is your company ready for sale? What can you do to maximize the value of your company in the eyes of prospective buyers? In summary, do you have a well thought-out plan? Transferring ownership of your business may be the biggest financial event of your life - you should have a plan.
Another survey, this one by ROCG, an international consulting firm, asked several hundred business owners who wanted to exit within 3 years if they had a plan. Eighty percent (80%) responded in the negative. The same survey asked "what is the most important objective in the sale of your company?" Eighty percent (80%) wanted to maximize the transaction amount. A good strategic exit plan gives you the best chance of receiving the maximum transaction amount.
Conversely, lack of a plan can cost you a lot of money. How do I know? It happened to someone I know. See the blog below titled "Strategic Planning".
Posted by John Gledhill on Tue, Aug 25, 2009 @ 09:13 AM
If you're at all like me (e.g. not a lawyer nor aspiring to be one), legal sounding words like "Due Diligence" go in one ear and out the other. You will, however, become intimately familiar with those dreaded words when you sell your company. Additionally, it makes sense to become familiar with them and incorporate them into your day to day business life - just in case you do have to sell your company when you least expect to. If something were to happen that would force a sale, you will want to have all your figurative ducks in a row.
Due diligence is one of the final steps in the process of transferring company ownership to a third party. Simply stated, it is the step in which the buyer makes sure that he is buying what he thinks he is buying. At this point in the sales process, a lot of energy has been expended by both parties and a lot of confidential information has been exchanged. Despite signed non-disclosure agreements, this information can seep into the marketplace should the deal be derailed during the due diligence process. And this is where most deals are derailed.
We recommend that our clients conduct a self-assessment due diligence prior to going to market. Most buyers will be looking for similar information, so it makes sense to organize the documents providing this information in a file which you can then hand to the buyer when they ask for it. This is perhaps the best way to combat the feeling of "buyer remorse" - an efficiently prepared documentation of all aspects of the company. It also makes sense to have a file like this even if you are not planning to sell your company in the foreseeable future; just make sure that you update it at least annually.
The buyer will want to review documents in the following general areas: legal, financial, human resources, and administrative. Legal documents include all those documents executed when your company was organized or incorporated, corporate records, financing documents (both bank debt and leases), property leases, intellectual property, and any regulatory matters. All details related to lawsuits past and present should also be included. Make sure that minutes of corporate meetings are documented so you aren't scrambling at the last minute to get them done. Finally, and most importantly, make sure that you have a corporate attorney review these documents for completeness and keep them in a safe and accessible location.
Financial documents to be reviewed include detailed income statements and balance sheets describing revenues, expenses, taxes, cash, accounts receivable (and payable), prepaid expenses, work-in-process, inventory, fixed assets, intangible assets, deferred revenue, debt, and shareholder equity. Obviously you will want your CPA involved in this process. Your financial statements should be prepared by your accountant (preferably with notes attached) and she should be able to assist you in preparing projected financial statements. Projections should be realistic but aggressive enough to interest a potential buyer.
Human resources documents to be examined include: company policies, processes, and practices; group insurance; retirement plans; key employees; training policies; internal communications methods; 1099 contractors; and contracts. If you have employees you should have an employee handbook listing paid holidays, policies for sick time, personal time, vacation, etc. An HR Consultant can assist you in this increasingly complex area if you don't have the time or patience for it.
Administrative items to be reviewed include: descriptions of real estate, insurance paperwork, travel and entertainment policies, and contracts (including customer, vendor, and maintenance). This last item is of special importance because the value of the company is impacted by the transferability of the above listed contracts. Again, have your lawyer review these documents for completeness.
The majority of deals that fall apart do so because they failed due diligence. Some of these failures are due to misrepresentation of company facts. Some are due to the seller trying to hide company "skeletons". These errors are almost always discovered during due diligence. Consequently, it is always better to fix the problem before you go to market, or bring it to the attention of the buyer at the start of the sales process. Waiting for these problems to be discovered during due diligence is a tremendous waste of everyone's time, and can render a crippling blow to the future salability of the company. On the other hand, a smooth due diligence process verifying all the information presented to the buyer greatly improves the odds of a successful sale.
Posted by Tom Gledhill on Mon, Aug 10, 2009 @ 10:20 AM
Positioning your company for prospective buyers is the most critical element in maximizing your company's value. Without the knowledge of what the buyers want you can't make the appropriate strategic decisions and you may leave a lot of money on the table.
Several years ago I worked with a company that provided information technology to the health care market. In what the owner thought was a logical growth pattern, the company expanded geographically into New York and New Jersey. He opened several sales offices in the area and hired salespeople to staff them. The cumulative cost of opening offices, hiring & training salespeople, travel, etc, was nearly a Million dollars. The company also had to pay trainers a premium (in addition to a per diem) as they didn't like to train in NY & NJ. Also, he found that the market there wasn't willing to pay their standard rates, so the system prices had to be decreased.
Ownership was also being urged by some of their "early adopter" clients to develop an electronic medical record (EMR). The company proceeded to do this at a cost of approximately $750K and installed the system in three of their clients' facilities at an extremely reduced price. The extra support and maintenance required produced an additional set of costs not reflected in the above.
The ultimate buyer already had sales offices in NY & NJ. The buyer was interested in penetrating New England and was having a hard time doing it. Also, they had their own EMR. They were not interested in my client's technology; they were interested in his customer base, especially in New England.
So how does this affect value? In most cases, a company's value is a multiple of cash flow or EBITDA (Earnings Before Interest, Taxes, Depreciation, & Amortization). If my client had NOT expanded into NY & NJ and NOT developed the EMR, he would have saved $1.75 million which would have been added to EBITDA. Since value is a multiple of EBITDA, the company value would have increased substantially. An even better strategy would have been to take a fraction of the money that was spent penetrating NY & NJ and add a couple of more salespeople in New England, thus increasing the customer base in the buyer's desired territory. This most likely would have increased the multiplier effect, further increasing the company's value.
So what's the lesson learned here? Research the type of buyer that is most likely to buy your company. By knowing that, you can make the correct strategic decisions that will increase the value of your company. A good M&A Advisor (Intermediary) will help you identify the appropriate buyer type for your business.
Posted by Tom Gledhill on Fri, Aug 07, 2009 @ 04:12 PM
A surprising number of businesses just don't sell. It's been estimated that only about 1 in 4 small businesses (less that $2 million) actually sell. Why is that? Well, first of all, 1 of the 4 would probably never sell for a variety of reasons (paltry revenues, losing money, no or little demand for their product or service, etc) and will simply close the doors. What about the other 2 that don't sell? Why don't they sell?
Unrealistic Expectations - this is the number 1 reason that many small businesses don't sell. It's human nature to think that the business that you've put so much of yourself into has a premium value. However, other parties ( Banks, Prospective Buyers, Valuation experts, etc) will look at your business objectively and apply universal rules in determining its value. In a previous blog (What is Your Business Worth?), I wrote of a boating business owned by 3 brothers (1 active in the business). It was a nice little business and very saleable except for one thing - unrealistic expectations on the part of the 2 inactive owners. They were not dealing with reality. They were in fantasyland! Note - because of the internet most of the prospective buyers are knowledgeable about the buying process and business valuation.
Lack of Information - many of the small businesses that I've dealt with over the years don't have accountant-generated financial statements. The accountant prepares the tax forms, why not have him/her take the next small step and generate the financial statements? The internally generated statements don't have all the accruals, depreciation amount, amortization amount and other items that more accurately reflect the performance of the company. Also, customer and vendor contracts need to be updated and readily available for examination. What about key employees? Do they have non-compete agreements or employment contracts? What motivation will they have to stay with the business once it's sold?
Landlord agreement - an assignable lease agreement with your landlord is critical if the present location of the business is important to the buyer. If you're an at-will tenant the landlord can do whatever he/she pleases. I'm familiar with a situation where the landlord, after 12 years and a seemingly good relationship, demanded a big chunk of the transaction amount in exchange for a lease for the buyer! This may seem extremely unethical (and it is!), but according to the lawyers there's nothing illegal about it.
If you're thinking about selling your business, it makes sense to perform a pre-transaction due diligence. Using a due diligence checklist, make sure that you have all the forms and financials that a prospective buyer needs. It also makes sense to have a valuation of your business so that your expectations will be aligned with reality. If you need a due diligence check list, let us know and we will provide you with one.
Posted by Tom Gledhill on Tue, Jul 14, 2009 @ 01:53 PM
Most business owners have a dollar value in their head about what their company is worth. And most of them are wrong. The vast majority of business owners overestimate the value of their business. They factor in the sweat equity that they put in starting the business, the long hours they spent building the business, the infrastructure that they've built, the employees they've mentored, and the customer and vendor relationships that they've developed. But in the final analysis the determining factor as to what your company is worth is: How much money is the company making?
Over the years I've had several people approach me with products or services that they've developed but had no money or expertise to market them. They had no revenues and no immediate prospects. They had no patents and their intellectual property was minimal. In cases like this, with no revenue and no track record, it's extremely difficult to find a buyer. Best they try to find a partner to invest some marketing money to get the company off the ground. Unless you have a product or service that is patentable and world-changing, a company that has zero revenues is worth just that - zero!
Several years ago I represented a company in the boating industry. I liked the owner and I liked the product. He had developed several channels of distribution and had good prospects for future business. Based on his financials and other parameters, I estimated that his company could sell for about $300,000. He seemed to accept that. I put together the marketing materials and developed a marketing plan and began implementing the plan. I did receive a couple of offers in the $300,000 range. I knew that the owner had three brothers that owned an interest in the company and I assumed that they had agreed to my estimate of value. How wrong I was! They flatly rejected the $300,000 offer. They (the brothers) said that the company was worth a Million dollars and they were not going to sell it for a paltry $300,000! The rest of the story - they never sold the company. They closed their doors about a year later and sold the remaining raw inventory for pennies on the dollar.
Except in rare industries, the value of a small company (typically under 2 million in revenue) is a multiple of Sellers Discretionary Earnings (SDE). SDE is defined as operating income (with re-castible adjustments) plus owner's salary. The multiple is typically between 2 and 3. It can be less than 2 if growth is negative, reputation is not good, location (if a factor) is not good, key employees are not staying, customer and vendor relationships are not good, etc. On the other hand, it usually takes all of those factors to be positive in order to rate a multiple of 3.
In the boating industry case above, the brothers would have needed an SDE of about $400,000 with a multiple of 2.5 (which I thought was about right) in order to justify a value of $1,000,000. Since their SDE was only about $120,000, the company was only worth about $300,000. Buyers use the same methodology to determine a fair price, so if you use something different that yields an inflated value, you'll be spinning your wheels if you try to sell at that price.
Posted by Tom Gledhill on Wed, Jul 01, 2009 @ 10:40 AM
WHY USE A BUSINESS BROKER?
Four Compelling Reasons a Business Broker Can Maximize the Value of Your Business
A business owner chooses to sell their business for a host of very good reasons. They range from a desire to retire, health issues, inheritance and tax planning, life style or other external reasons. In all cases, the business owner has one objective, TO MAXIMIZE THE VALUE OF YEARS OF HARD WORK.
A business broker who serves as a value added advisor, agent and planner is essential to navigating the owner through the business assessment process, framing or packaging the business for sale, valuing and pricing,, buyer identification and the purchase and sales process.
Here are four attributes your business broker must have to optimize your business value:
1. BUSINESS ADVISOR: Objective assessment of your business and its value with direct counsel on tangible actions to take in the near term to maximize value. In addition your broker will prepare an informational package describing the business, assist in evaluating offers, negotiate terms and conditions, utilize banking contacts to arrange financing to minimize or eliminate the need for seller financing.
YOUR BUSINESS BROKER MUST WORK WITH YOU TO INCREASE THE SALES PRICE!
2. PROCESS EXPERTISE: A thorough understanding of the purchase and sales process that will expedite the transaction. Selling a business has eight discrete steps. Your broker should know each step cold, explain each one to you, execute each one to your jointly developed plan and monitor deal progress to the plan
YOUR BUSINESS BROKER MUST KEEP TRANSACTION ON TRACK!
3. NETWORK OF BUYERS: A national network and infrastructure that tracks interested buyers and investors will allow for a more robust pool of buyers. Your broker must have that network, in addition to qualifying all potential buyers on their financial capability and motivation.
YOUR BUSINESS BROKER MUST HAVE A BROAD AND NATIONAL NETWORK TO DRAW THE LARGEST POOL OF QUALIFIED BUYERS AND INVESTORS!
4. INDEPENDENCE AND OBJECTIVITY: Representing you and your business with independence and objectivity is imperative to maximizing its value. Your broker should understand the importance of maintaining confidentiality. Further, your broker should share information about your business with prospective buyers at the right time and in the right amounts based on interest and motivation. Your broker should be part of an accredited national organization with a strict code of ethics and professionalism. In addition, your broker should have an accomplished and diverse background as a business advisor, covering multiple industries and brokering deals of varying size.
YOUR BUSINESS BROKER MUST BE A TRUSTED ADVISOR!
Posted by Tom Gledhill on Wed, Jul 01, 2009 @ 10:32 AM
Several years ago I was sitting around a table in a conference room helping to negotiate a letter of Intent (LOI) between my client, a small $5M Telecom company, and a prospective buyer. Suddenly a knock came on the door and the business owner opened the door and went outside. He returned about 5 minutes later and beckoned me to follow him outside. "We just learned that we lost ABC Company as a client. They recently hired a new purchasing agent and he decided to go in a different direction. We'll have to end the negotiations and take the company off the market. We also need to cut our staff and restructure the company".
Why was ABC Company so important that they had to cut staff and restructure the company? Because ABC represented 52% of their total revenues! As their business broker I knew that when I took them on as a client, but I rationalized that since ABC was a multibillion dollar company that a strategic buyer would want an "in" to this company that had offices and manufacturing plants all over the globe. That may have been true for just the "right strategic buyer", but finding that buyer was like looking for a needle in a haystack. We had found a buyer who was willing to negotiate, but it was clear that the high "customer concentration" was going to seriously affect my client's value. With the loss of ABC Company not only did the negotiations with the strategic buyer end, but my client was struggling for survival. In the end my client survived as a much smaller company and the owner ultimately transferred ownership to a key employee for a fraction of the company's former value.
This is just one example of how high customer concentration can seriously affect the value of a company. It represents a risk to the buyer, and risk is directly related to a company's value. The buyer mentioned above was fortunate that the loss of ABC Company happened when it did - although the timing didn't have to be so dramatic!
If you, as a business owner, are in a position where one or a few clients represent a big chunk of your total revenue, you must try very hard to diversify your source of revenue so that you're not so dependent on a few large clients. This, of course, is easier said than done. If you can't diversify, or the timeline to accomplish it is long, make sure that you're prepared for the eventual loss of one or more of these big clients. Also, you must accept the fact that your company's value will be seriously affected in the eyes of prospective buyers.