What Factors are the Largest Detractors of Value for my Business?

Business owners who are thinking about an exit often-times want to know what challenges they will face in a sale process and whether or not someone else will want to own their business after them.  A solid exit planning process includes both personal and business factors to be considered.  On the business side, it is helpful for an owner to know about the elements that are likely to reduce the value of their business in the eyes of potential buyers.  When an owner is aware of these factors, it is likely that these ‘risks’ can be mitigated over time, leading to a higher exit value for the business.  This newsletter takes a look at the factors that generally reduce the value of a business and provides some recommendations as to ways that owners can address these items years in advance of an anticipated exit or sale transaction and therefore increase not only the potential value of the business, but also the overall likelihood of a successful sale. What Buyers Fear Most As an owner who is thinking about a future exit, you are well served in understanding the concerns and fears of potential buyers for your business.  The largest fear that a buyer has is that of the unknowns and the risks that accompany not knowing what the future holds.  In other words, privately-held businesses do not report earnings in the manner that publicly traded companies do.  Therefore, when it comes time for a buyer to review your business for purchase, they will have countless questions about how the business operates, the markets that it serves, key people who...

Is My Industry the Largest Driver of Value for My Business?

Business owners considering an exit often want to know who their likely buyers will be and how much money those buyers are willing to pay. In order to forecast a realistic sale price, owners often look to standard metrics such as the ‘multiple of earnings’ – a valuation theory based on the idea that similar assets sell at similar prices. This way of thinking often leads business owners to the quick conclusion that the easiest way to increase their business value is to increase the earnings of the business. This newsletter examines that basic concept and challenges this conventional thinking by first asking the question, “Does the industry that you are in have the largest impact on the value of your business?” Value is a Prophesy of Future Cash Flow The most important concept in valuation is the idea that a future buyer for your business will pay you for the cash that they expect to generate from your business in the future. A prospective buyer will only write you a check for your business if they are confident that there is a ‘future’ for your company. The price and terms a buyer will pay are driven by the riskiness of the future, as they perceive it. There are three (3) important items to consider: Increased profitability will generally drive your company value higher. Reduced risk in your business will also drive your value higher. The industry in which you exist will produce willing investors who can best evaluate the risks of future cash flows. In reality, in order for an owner to monetize their illiquid business, they need...

Are Your Company’s Earnings or Risk Factors More Relevant For Your Successful Exit?

Most business owners at some point in time want to know the value of their privately-held business.  Further, many owners who see their ‘exit’ as being many years in the future would like to know what they can do today to improve and grow that value. This newsletter asks a rather simple question for owners to consider today, “is it better to increase your profits or to reduce your ‘transition risk’ in order to increase the value of your business?” The Risk and Return Formula For Valuations A buyer of a business will pay for the cash flows that they believe will happen in the future, which is measured by the overall riskiness of those forecasted cash flows being achieved. Let’s translate this a bit further.  A business is worth what someone else is willing to pay for it – that is the ‘price’ at which a business may sell.  However, the ‘value’ of a business today can only be measured using certain specific ideas about how a future buyer would view the business.  As a general rule, buyers will pay for future cash flows but only at a rate at which the riskiness is properly reflected.  Therefore, a complete analysis of how to increase the value of your business must include both increasing profits (i.e. cash flows) as well as analyzing and reducing risks in the business. EBITDA Multiples Many owners are familiar with ‘industry multiples’ for sales of businesses.  For example, many owners will understand what it means when someone says that “Jim sold his manufacturing company for ‘5 times’ the company’s earnings”.  The ‘5 times’ is...

Private Equity Backed Strategic Competitors as Buyers for Your Business

Business owners who are thinking about an exit via an external sale will often want to know ‘who is the best buyer for my business?’  In many cases, smaller businesses are unable to attract significant buying interest because they lack fully developed management teams and they do not command a large enough share of the marketplace to create a compelling story. This newsletter is written to make you aware of this marketplace reality in an effort to help you envision who may one day want to own your business. Private Equity and ‘Platform Companies’ Described The words ‘private equity’ and ‘platform’ companies can sound a bit intimidating at first to many owners.  The words alone ring of institutional, non-personal entities that are simply in the pursuit of financial rewards, unable to ever understand the delicate nature of an owner’s private business.  Well, while private equity groups are professional investors who purchase private businesses to grow and improve their value, they are often-times owners themselves and are frequently industry experts who are able to bring great value to the companies that they purchase.  The key to understanding private equity is knowing that for an initial investment the private equity wants a certain minimum level of profitability to make the acquisition work.  And, once that initial acquisition is made, the private equity backers of the company will often work with the CEO to acquire additional ‘bolt on’ acquisitions to grow (and perhaps diversify) the business. A ‘platform company’ therefore is one that the private equity initially purchases that puts them in a certain industry.  A minimum annual profitability of $2 million...

How to Exit Different Sized Businesses

‘Exit Planning’ is the process that a business owner follows in preparing for the largest financial and emotional transaction of their life – i.e. the transition of their privately-held business to a new owner. Now, despite the fact that ALL owners will one day leave their business, it is true that different sized businesses will have different exit options available to them and, therefore, owners need to know where they fit on the exit planning transfer spectrum as well as how to begin your exit planning today. The Exit Planning Transfer Spectrum The exit choices that are available to privately-held business owners are largely dependent upon the size of the business.  In our case, we’ll generalize by measuring the size of a business both in terms of revenue, the number of employees, and annual profits.  The Exit Planning Transfer Spectrum below will assist you in seeing where you fit. The Exit Planning Transfer Spectrum Solo Micro Lower Middle Mkt Upper Middle Mkt Revenues (millions) $0- $1m $1m – $5m $ 5 m -$30m $30m – $150m # of Employees 1 to 5 5 to 15 15 to 50 50 to 200+ Annual $$ 50k to 350k $350k to 800k $ 800k to $2mm $2mm to $10mm It is important to note that these size ranges by revenues, number of employees and annual profit are generalizations, not evenly applicable to every business and industry.  This transfer spectrum is intended to help you calibrate where you fit in terms of the size of your company and how you can devise a plan for an exit.  So let’s look at each segment to see how different sized businesses...

Owner Preparation for a Future Exit

Owner Preparation for a Future Exit An owner’s exit from a privately held business is a complex process that impacts nearly all of the people and other constituents associated with that business. As a result, many owners will not execute on an exit plan until they have a high level of comfort with how and when this large change will affect them and the people involved with their organization(s). The purpose of this newsletter is to address the types of things that owners can do in anticipation of a future exit to attain a higher level of comfort with many of the unknowns that accompany an exit strategy and implementation process. Where Effective Leadership Intersects with Personal Desires and Goals When an owner begins to consider how and when they will exit their business, they often face the dilemma of putting themselves ahead of their company, employees, vendors, customers and anyone else associated with their organization. This is often difficult to navigate because, at some level, the leadership skills that made the owner successful to begin with – such as putting other’s needs ahead of their own (i.e. employees, customers, key business relationships, etc.) – now creates a feeling of conflict when deciding to plan an exit. The owner must face the necessity of putting himself or herself ahead of everyone else, which frequently proves to be difficult. In fact, owners beginning this process often say, “My family comes first, but my employees and company are a very close second.”  Therefore, in order to strike a balance in how an exit will impact all of the different people, the...