In our succession planning work with independent business owners, our first step is to value the business so that we know the value of the asset, because this value forms the basis for our succession planning analysis and implementation. Following the determination of value, our next step is to provide the business owner with steps to maximize the value of the business. Many business owners have growth strategies that focus on increasing sales, but this does not necessarily increase the value of the business. Therefore, we would like to share the following five strategies for increasing business value.
1. Get an Independent Audit: This is especially important if you are considering selling your business to a third party (as opposed to a family member or your employees). Buyers will be keen to dig through your financial statements to look for areas they can identify as problems that can either reduce their offer or cause them to walk away from a potential deal. In order to avoid this problem, engage an auditor to complete a thorough audit of your financial statements so you can answer questions before they are posed by a buyer.
2. Diversify Away from the Owner and Key Employees: Most of the succession planning work we do is with companies whose revenue is below $30 million, and in most cases, the owner and possibly one or two key employees are the primary reason that the company is successful. While these owners and key employees should be commended for the work they have put into building a successful enterprise, a business that cannot function without the owner and a few key employees is not very valuable to an outsider. Therefore, it is critical that a plan is developed to create self-sufficiency among the employees and managers. Transitioning roles and responsibilities away from an owner and key employees takes time and tends to create strong emotions, so starting early, being transparent, and having a well thought out plan can help your business run more efficiently, be more profitable, and continue its legacy in the community.
3. Create Strategies for Increasing Profitability: Business value is derived from productively turning assets, both human and financial, into cash flow. A new owner is paying you for the stream of cash flow they expect your business to create in the future, discounted for reasonable risks. Therefore, one strategy we suggest for increasing profitability is to go through each expense line and determine whether it is in-line with industry averages and whether this expense is the best use of cash. Many business owners are surprised at what expenses they have accrued over the years that are not core to the functioning of their business. The second strategy we suggest is to consider raising your prices by 5%-10%. Many business owners are hesitant to raise prices because they don't want to lose customers. However, we have found that owners who truly have created a niche and serve that niche well are valued above the prices they charge and can increase their margins by raising prices. Regardless of whether you are reducing expenses or increasing revenue, higher margins lead to higher net cash flow, and higher net cash flow creates a more valuable business.
4. Diversify Your Customer Base: A quick test for a business owner is to see what percentage of sales come from their top 3-5 customers. If it is greater than 25% or 30%, it is usually a good idea to try and diversify your customer base within your niche so that if one or two large clients leaves or reduces their purchases due to an ownership transfer, it does not create a potential cash flow issue for the incoming owner (and your payout). A new owner who is concerned about customer concentration is likely to negotiate for a lower price or walk away from the deal.
5. Speed Up the Reporting of One-Time Expenses: If you know you will have to write off inventory or will not collect certain receivables, the sooner you report these, the better. Many valuations are done based on the trailing twelve months of Earnings Before Interest Taxes Depreciation and Amortization (EBITDA), and the sooner you write off a one-time expense, the quicker it will disappear from your trailing twelve-month EBITDA. The other positive to a buyer of speeding up any one-time expenses is that it shows them that you are operating your business honestly and transparently. Trust is hard to quantify, but it is vital to a successful ownership transition and may just add to the price a buyer is willing to pay.
As always, the specifics of your business will determine which of these five areas are the most critical for increasing value, and the earlier you start your succession planning work, the more time you will have to create a plan that can maximize the value of your business.