By Jonathan Benner
A fundamental aspect of a successful business owner’s exit is to assure that the business has enough value to allow for financial security. This, coupled with wisely invested non-business assets, gives you the best chance to pursue the exit path you want on the timeline you want. Obtaining a proper, professional business valuation is the first step in determining how much your company is worth, but what happens if the valuation shows that your business isn’t worth enough to allow you to exit your business with financial security? How can you increase your business’ value if everything that’s made it successful thus far isn’t enough?
The answer lies in installing value drivers. So, what are value drivers? Value drivers are specific business characteristics that drive growth. While each business is unique, there are six areas of your business that, with focus and a little time, can have the greatest impact on your company’s value.
These six value drivers represent characteristics of a business that either reduce the risk associated with owning the business, or enhance the prospect that the business will grow significantly in the future.
Let’s dive a bit deeper into each of these characteristics:
In all likelihood, as an owner of your business, you are absolutely critical to its success. Without you, there probably is no business. If you are going to leave one day, this has to be fixed! You must become an “inconsequential owner” surrounded by a team of motivated people with a variety of skills who are incentivized to stick around for the long haul. If a company has a solid management team, a buyer will likely assume that customer relationships can be maintained, and that the company’s reputation will remain intact. Buyers conclude that the company will continue to grow with its existing management and will demonstrate their confidence in future cash flows by paying a higher sale price.
The second value driver is the development and documentation of business systems that generate recurring revenue from an established and growing customer base. Business systems include the computerized and manual procedures used in the business to generate its revenue and control expenses (i.e., create cash flow), as well as the methods used to track how customers are identified and how products or services are delivered. The establishment and documentation of standard business procedures and systems demonstrate to a buyer that the business can be maintained profitably after the sale.
Established & diversified customer base
Put on those buyer’s shoes one more time and you’ll find yourself shuffling past companies with great management teams and excellent systems, but whose cash flow primarily is dependent on one or two customers. Why spend millions of dollars on a business only to have those customers go elsewhere after you’ve acquired the company? Another value driver, then, is the development of a customer base in which no single client accounts for more than 10 percent of total sales. A diversified customer base helps to insulate a company from the loss of any single customer.
Proven growth strategy
Buyers pay premium prices for companies having a realistic strategy for growth. That strategy must be communicated to a potential buyer in such a way so that a buyer can see specific reasons why cash flow and the business itself will grow after it is acquired. The growth is illustrated in pro forma statements that will be used by buyers and investment bankers when formulating a discounted future cash flow valuation of your company. Building and documenting a positive growth story, however, is only 90 percent of the game. The remaining 10 percent is knowing how, when, where, and to whom to tell your story. The storytelling takes place during the sale process and is done with the guidance and assistance of an investment banker or other transaction intermediary. That is the time when you force savvy buyers (meaning those with lots of money) to pay for the value you have created in your business.
Effective financial controls
Financial controls are not only a critical element of business management, but also safeguard a company’s assets. Most importantly, however, effective financial controls support a claim that a company is consistently profitable. When you decide to transition your business, the buyer will perform some level of financial due diligence. If the buyer’s auditors are not completely comfortable when reviewing your company’s past financial performance, you have no deal or, at best, a reduced value for your company.
Stable & increasing cash flow
Buyers purchase cash flow, and they pay top dollar for cash flow that they expect to increase after they buy the company. Think like a buyer. Which company would you rather buy?
Notice in the chart above that the total cash flow for each company is the same, $6 million over three years (2016-2018). Yet company B has a better story to tell because its immediate past and present cash flow have improved and continue to improve. It is important, especially in the year or so preceding the sale of the business, that cash flow is substantial and on an upswing.
Whether a buyer will pay a premium price for a business depends, in large part, upon the efforts of the owner to adopt and implement the value drivers described in this article. These value drivers were not dreamed up by a business school professor, but are what professional, sophisticated buyers say they seek in closely held businesses. Concentrating on developing and enhancing each value driver will position you to get a premium price for your business.
Jonathan Benner is a Certified Financial Planner™ with LPL Financial in Chesterfield, Missouri. He and his team have the unique capabilities to help business owners with the single-most critically important issue impacting their lives – how to exit their business most effectively. He can be reached at firstname.lastname@example.org.