Posted by John Gledhill on Tue, Oct 06, 2009 @ 02:08 PM
If you took an Electrical Engineering course in college, you probably remember (vaguely!) the voltage formula V = IR. Well, a good basic formula when thinking about increasing value in your company is V = I/R. V is value of course. I stands for "Increased Cash Flow" and R is "Risk". Since Risk is the denominator in our formula, decreasing Risk increases Value. Let's take a quick look at each of these elements.
When thinking about increasing cash flow the first thought that comes to mind is to increase sales. But be careful you don't go after low- or no-margin work in an effort to simply increase volume. If your gross margin dips below the industry average you will hurt your company's value. Also - watch your expenditures. Clean up your P&L and eliminate any unnecessary expenses. The most likely valuation of a profitable private company involves the capitalization of cash flow; so every dollar saved on your P&L equates to two to four dollars (or more) of value in your company.
To decrease risk you'll want to put yourself in the shoes of a potential buyer of your company. What would you want to see if you were looking at your company for the first time? First, you will want to have updated information systems, including up-to- date accounting software such as Quickbooks. Second, make every effort to maintain a diversified customer base. Customer concentrations for any single customer of greater than 25% can drag down value. Finally, make sure that you the owner are as separable from the company as possible. Train managers or key employees and delegate as many duties as you feel comfortable to these employees. A business is difficult to sell if the owner is too embedded in it.
If you do a little each day to increase the cash flow and decrease the risk of your company you will be sure to increase its value over time.
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.