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Build Value Before Selling a Business

 work team building value before selling a business

Have you ever wondered why one business has buyers lining up to pay top dollar while another sits on the market for months or years? What do buyers look for when buying a business?  


Value Drivers to Consider When Selling A Business

The characteristics buyers seek are called Value Drivers, and to be effective, they must be present long before a business sale process begins. Value Drivers are business characteristics that either reduce the buyer’s risk when buying the business or enhance the potential for long-term business growth. It's the job of a business owner to improve these Value Drivers before selling their business. The most important Value Drivers are: 

  • Consistent and increasing cash flow.  

  • A motivated management team.  

  • Business processes that support sustainable cash flows.  

  • A diversified customer base.  

  • A business facility and equipment consistent with value expectations.  

  • A clear path to growth.  

  • Quality accounting and financial controls.  


Buyers are willing to pay top dollar when the perceived risk of acquisition is low and the potential reward of ownership is high. In that respect, it's no different than any other investment.  


There are many things that create value, including intellectual property like patents and know-how, brand reputation and market position. In this article, we'll focus on the Value Drivers that are common to most businesses, including the management team, business systems, customer base, facilities and equipment, growth strategy, and financial controls. But first, let’s look at why consistent and increasing cash flow is so important in the business sale process and what you can do to achieve consistent cash flow. 


Buyers buy cash flow. 

Ultimately, all Value Drivers contribute to predictable cash flow. Cash flow influences what a buyer is willing to pay and how much they can borrow to fund the acquisition. Buyers pay top dollar for cash flow that they expect to increase after they buy the company.  

It’s important, especially in the year(s) leading up to selling a business sale, that cash flow be substantial and rising. The buyer will also look for company earnings to continue increasing even throughout the sale process (which can take a year or more). So a critical question to ask is: How do you go about increasing your company’s cash flow? 

  • Re-commit your energy to the business. If you've been scaling back your time at the office, consider re-engaging to focus on projects that will improve profitability and cash flow. Every business owner experiences a degree of complacency over time. When you’re considering a business sale, find ways to rekindle the passion you had when you started the company, and push it to new heights.  

  • If the company is funding significant "perks" for the ownership team (e.g. company car, club memberships, travel and dining, etc.) consider scaling them back. Running these expenses through the company reduces taxes, but it also reduces cash flow and thus the business valuation. If you elect to keep these perks in place, then make sure they are easily discoverable because your M&A advisor will adjust them out of your historical income statements as part of the sale preparation process. If your perks are buried in years of credit card statements than recasting your financials will be labor intensive and subject to a high degree of buyer scrutiny.  

  • Think carefully about capital expenditures. Postpone any non-essential purchases. There is a balancing act here: investments to keep the company running are essential, but capital expenditures without a clear payback within the timeframe in which you plan to sell should be avoided.  

Consistent and increasing cash flow is critical to attracting buyer interest, but there are other value drivers that buyers will look for.  


Strong Management Teams Increase Business Value. 

The experience and depth of your management team is a key value driver. A company that is heavily dependent on the owner(s) or even the owner's family members is viewed as a risk. A business sale will likely provide the owner(s) with a life changing sum of money. Regardless of what buyers say, they plan for the owners to fade away not long after a transaction, and they have to assume that family members might leave too. When that happens, is the remaining management team capable of operating the business successfully, and are they likely to stick around long term?  


If a company has a solid management team, buyers will likely assume that customer relationships can be maintained, the company’s reputation will remain intact, and the company will continue to grow with the existing staff. They will demonstrate their confidence in future cash flows by paying a higher purchase price. 


How, then, do you keep management in place until you sell the business? If you’re planning to sell the business now, it's too late to implement any type of long-term incentive plan. Instead, your best bet is to keep your key managers by paying them lots of money in the form of additional salary and performance bonuses. Establishing stay bonuses for employees who remain with the company can be effective in keeping the team together and demonstrating your commitment to the company's success after the sale. 


If you don’t plan to sell your business for at least a year, consider an incentive compensation system, either cash- or stock-based, that rewards key employees as the company performs. For example, set aside a percentage of improved profits for management bonuses. Part of incentive compensation should be paid currently while the other part is deferred, to be paid only if they stay long-term. No matter the length of the “pre-sale” period, it is crucial to keep your key management in place. 


Documented Business Systems Improve Earnings Consistency. 

In addition to building a solid management team, owners must build reliable operating systems that can sustain the growth of the business. The second Value Driver is the development and documentation of business systems that generate recurring revenue from an established and growing customer base. If you leave shortly after selling your business, what remains? If the answers are “capable management” and “highly efficient business systems,” you’ll be able to leave your business in style and feel good about what you’ve left behind. 


Business systems include both the automated and manual procedures that generate revenue and control expenses (i.e., create cash flow), and the methods used to track how customers are identified and how products or services are delivered. Solid, well-documented business procedures and systems demonstrate to a buyer that the business can be maintained profitably after the sale. They also provide a framework for bringing on new employees efficiently and scaling the business.  


Put yourself in the shoes of the would-be buyer for a moment. You want assurance that the business will continue to move forward under your ownership and that operations will not break down if (and when) the former owner leaves. This assurance comes from documented systems that enable the buyer to carry on the work of the former owner. The following systems enhance business value whether you plan to sell your business now or decide to keep it: 

  • Personnel recruitment, training, and retention.  

  • Human-resource management (e.g., an employee manual).  

  • New customer identification, solicitation, and acquisition.  

  • Estimating, contracts and billing. 

  • Product or service development and improvement.  

  • Inventory and fixed asset control.  

  • Quality control.  

  • Customer, vendor, and employee communication.  

  • Selection and management of vendor relationships.  

  • Business performance reports for management.  


Systems and procedures vary depending on the nature of a business, but, at a minimum, those resources and activities necessary for the effective operation of the business should be documented. 


Buyers Look for An Established and 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 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? A prudent buyer will structure a buyout to protect against the loss of a key customer, typically by making much of the purchase price contingent on the key customer’s continued presence or, if that cannot be guaranteed, requiring the seller to carry a note for the bulk of the purchase price. As a seller, binding a significant portion of your financial security (for several years) to your former company and its customer(s) is risky. 


Thus, another Value Driver is the development of a customer base in which no single client accounts for more than 10% of total sales. A diversified customer base helps insulate a company from the loss of any single customer. This can be problematic when you’re building a business with limited resources and one or two good customers are willing to pay for everything you can deliver. If this is your situation, consider raising your prices to those big customers. If that reduces your sales to them, you're on your way to a more diversified customer base. If raising prices doesn't reduce sales to your big customers, then you'll have more cash flow to invest in business development and capacity for new customers and you're still on your way to a more diversified customer base.  


Facility and Equipment Condition Matters. 

Appearances matter. You’re about to show your facilities to a potential buyer. If the buyer is being asked to pay millions of dollars for your company, he or she will want the business to look like a million dollars. A good-looking facility shows that you’re proud of your business in every respect and that you’ve made the necessary investments to keep it going. It also indicates that you haven’t deferred maintenance, leaving future capital investment requirements for the buyer. A clean, well-organized office sends the message that the business is also clean and well-organized. A few thousand dollars of superficial improvements can improve the marketability of your business and increase the interest of potential buyers. 


Business Owners Need A Realistic Growth Strategy. 

Buyers pay premium prices for companies that have a realistic strategy for growth. That strategy must be communicated to a potential buyer to show specifically how cash flow and the business will grow after acquisition. buyers use pro forma financial statements to formulate a discounted future cash–flow valuation of your company. This valuation typically determines what a buyer will pay for your business. 


Because future cash flow is based on estimates of future growth, a realistic growth strategy should be articulated, based on the following: 

  • The dynamics and trends of your industry.  

  • Increased demand for the company’s products based on population growth or other factors.  

  • New products and product lines.  

  • Sales and marketing plans to grow market share.  

  • Growth through acquisition.  

  • Any other opportunities for future growth unique to your business. 


Without a written plan, a buyer can’t appreciate the growth opportunities your company offers. Even if you expect to retire tomorrow, you need to have a written plan describing future growth and how that growth will be achieved.  


Effective Financial Controls Are a Must. 

Another key Value Driver is reliable financial controls used to manage the business. Your financials are not only a critical element of business management, but also safeguard your company’s assets. Most importantly, effective financial controls support your claim that the company is consistently profitable. 


A buyer will perform some level of financial due diligence, usually in the form of a Quality of Earnings (Q of E) report. If the buyer’s due diligence team is not completely comfortable when reviewing your company’s past financial performance, you have no deal, or at best a reduced value for your company. 


Once again, put on those buyer’s shoes. You’re buying a company that you might not have even heard of three months ago. The owner of the business says that the company has been making $5 million per year for the past three years and is projected to make at least that much in the future. You think: “prove it.” If the seller produces past financial statements that prove incorrect, insupportable, or incomplete, you will be highly skeptical or, more likely, entirely uninterested in buying. You would never pay millions of dollars without knowing for certain what the company’s cash flow has been. You need to have complete confidence in the past financial activity of that company. 


The best way to document that the company has effective financial controls and that its historical financial statements are correct is through a certified audit, or at least reviewed financial statements from an established CPA firm. Business owners often view financial audits as an unnecessary expense, or as a necessary evil required by their banks. In reality, an audit is an investment in the value and marketability of your business.  


There are three levels of accountability available from CPA firms. The first is a compilation, where your CPA simply compiles the financial information that you provide into a report. In a compilation, the CPA firm makes no representations regarding the accuracy of those financial statements. It’s unlikely that a buyer of a mid-sized company would be comfortable with financial statements, except as a preliminary idea of what the company says it has done. A compilation can be the basis for discussions, but certainly not the basis of an acquisition. 


The next level of accountability is “reviewed” financial statements. This means that the CPA firm has reviewed the financial information and determined that it is accurate, based on your representations to the CPA firm. It’s common to see sales of mid-market companies in which the buyer requires only reviewed financial statements. 


The final level of accountability is “audited” financial statements, in which a CPA firm verifies that the financial statements are accurate, based on its own investigation. 

Put yourself back in the buyer’s shoes one last time. Which level of assurance is most desirable? Which makes you more willing to pay top dollar for a company? Obviously, it’s the independently verified, audited statements rather than the unverified claims of a business owner anxious to leave his or her business. 


You can understand why it’s likely that audited or reviewed financial statements will be required. These should be prepared 1-3 years before you begin the sale process. It’s very important to use the services of a recognized, reputable CPA firm for this work. The purpose is to uncover any financial irregularities or inadequacies as soon as possible so that you can correct them long before a buyer becomes involved. 


Conclusion. 

Whether a buyer will pay a premium price for your business depends, in large part, on your efforts to implement the Value Drivers described in this article. These things were not dreamed up by a business school professor. They are what we hear professional, sophisticated ask about every time we bring a client to market. Concentrating on developing and enhancing each Value Driver will position you to get a premium price for your business. Failing to do so can keep you stuck in a business you want to leave. 

 

About Venture 7 Advisors:

Venture 7 Advisors is a team of merger and acquisition advisors who assist the owners of small and mid-sized companies to plan and complete the sale of their business. We find the best buyer to meet each business owner’s financial and legacy goals. We represent clients in consumer products, distribution, manufacturing, B2B services, construction, telecommunications, and eCommerce from offices in Burlington, Vermont, the Hudson Valley, New York, and Western Massachusetts.    


We're here to talk about your situation, provide information, discuss your options, and put things in perspective. Contact us at any time:


Bryan Ducharme

Managing Partner

Mobile: 802 578 6462


Scott Hardy

Partner, Master Entrepreneur

Mobile: 802 373 6762

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