It is estimated that approximately 60% of
the small businesses in Canada today are owned by baby-boomers. Over the next
15 years these business will need to be transitioned to ownership. Estimates
are that only 10 to 15% will be transferred successfully. The other 85 to 90%
will die and leave room for new market entrants. These are not good odds if you
are thinking that your current small business is material in funding your
Whether you are transferring, selling, adding or buying a business, at some point in time you will need to put a value on that business. Whether selling a business or gaining additional financing you will want to maximize the value of your business. If you are looking to buy, you want to make sure that the value of the business is sustainable over the long term.
The common theme between investors or lenders is the access to cash and more importantly, getting a return on that cash. As a seller or a borrower the common theme is the need for cash with minimal risk or cost attached. As a seller, buyer or investor common principles begin to emerge. That common principle is what is the best alternative to the considered deal that sits before them. It is good to know the Net Present Value (NPV) concept as deals are usually valued using NPV.
NPV is simple and works well when considering dissimilar options such as buying a business or investing in secure (almost) risk free government bonds. As investments become more risky, the return expected goes up as well. So bonds may trade at 8% yield, however riskier investments would be expected to return 15% or even 25% to compensate for unknowns. The effects of risk and increased expected return rates mean that the NPV value will decrease. Basically this means a $1.00 per year (over 5 years) returned at 5% will be worth $4.33 versus the $3.35 a 15% yield will return in today’s dollars. Lesson learned: the risky your business the less the NPV will be and hence the less you get for your business or can borrow for your business.
There are many factors that go into measuring the riskiness of your business:
- The markets you serve – are
they easily impacted by recessions? Is it crowed with “me too” products. Is the
market growing or in decline.
- Small versus big. Bigger
companies tend to offer less risk for investors. Start-up companies tend to be
smaller and therefore riskier. Smaller companies do not have the ‘deep pockets’
that larger companies do.
- Quality of revenue – more
customers paying monthly revenue streams is better than a few companies paying
one time non recurring revenue such as professional services or single contract
- Capital and cost structure of
business – what percentage of your company is funded through debt or equity.
Are the various expense ratios in line with similar companies in your market or
- Other items such as:
- Quality of customers and
suppliers; are they all your relatives or best friends? How attached are your
customers and suppliers in terms of contracts terms and conditions?
- Third party interests in your business. There may be multiple partners who have a decision in the acquisition process.
- Strength of management team. Often, in terms of intellectual capital, the owner is the company, or there are one or two key people who, without, can materially impact the company operations.
- Quality of customers and suppliers; are they all your relatives or best friends? How attached are your customers and suppliers in terms of contracts terms and conditions?
Many things can be done to minimize risk and maximize the value of your company.
- The first thing to do is clean up your income statement. Reduce discretionary spending on office parties for your relatives and customers; remove that car expense and other personal perks that have helped you to reduce tax expenses over the years. New owners will not likely see any value in these expenses. This will serve to beef up the cash flow and hence value of your business.
- Clean up your balance sheet. Make sure your assets are reflected correctly on your books. Make sure your technology is not obsolete. Make sure you are only carrying the assets you need to run the business.
- Clean up your debt structure. Some debt is good – it provides leverage for earnings growth. Make sure you are not paying for assets that are no longer useful. Make sure any “off the balance sheet financing” (ie: items linked to take or pays, royalties on development etc) deals are identified as they can become restrictive to new owners.
- Start creating people depth in your organization. Make sure that one or two people leaving will not collapse your business. Make sure when you leave your customers do not go with you. Also, make sure you have good HR practices employed.
- Create solid customer and supplier contracts that reflect terms that would normally be achieved through prudent business practices.
- Create operational metrics that prove best practices are being followed and followed well. An efficient, responsive and effective operation provides the capacity to earn that return on investments. Think of this as the catalyst to earning a premium for your business.
- Focus on a quality top line. Good revenue is attached to long-term contracts with recurring revenue. Low risk paying customers always return a better yield than deals struck with your in-laws and/or cousins.
- Create that business and marketing plan. It provides an owners manual to prospective purchasers and investors on how well run your organization is. It also explains why your business is different from all the other “me-too” offers out there any why someone would say “yes” to you and “no” to the competition.
The first 2 to 3 items can be well managed with a good accountant at your disposal. The last 5 items require you to work “on your business” not “in your business”. For owners, this is very tough as it means letting go and making tough calls sometimes.
If there were one piece of advice I would like to offer above more than anything else it would be to start early. These issues cannot be resolved a month before you sell or gain financing. Any thorough analysis would show that you’re putting on a façade. Start early and let the culture of your organization yield the results required.
I guess the title should have read “9 things to do to help maximize the value of your business”.
In : Business Practice
Tags: "business valuation" "financing" "sell business"
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