A business and its owner(s) maintain an interesting relationship. The interplay between the individual and the organization often represents a tremendous source of pride and accomplishment as well as a wellspring of stress and worry. Setting aside these feelings for the moment, a business more tangibly provides the means by which owners create value for themselves (let’s not forget other shareholders and employees). Generally speaking, value creation comes in the form of providing an earnings stream over the course of a business’s life that allows the bread to be put on the proverbial table. It helps to pay for the kids’ education, retirement as well as your home and lifestyle. The other value creation avenue comes upon an exit, where a new owner identifies future opportunity that can be captured from the foundation you built and is willing to pay for it.
The different paths to take would seem to warrant completely different perspectives and decision making logic, but I would argue they don’t need to be so diametrically opposed nor should they be. I always like having options and so should a business. Building a business with the motive that it will never be sold may lead to certain decisions that reduce strategic flexibility down the road. I “get” not all businesses are for sale and they don’t need to be, but managing a company that can be transferred, whether intended to be or not, introduces some intrinsic value that may not otherwise exist.
So what do you need to focus on? At the end of the day, it is about properly balancing near-term opportunity and reward against risk. If you can de-risk your business by implementing strategies that drive towards a diversified business model, your organization becomes more sustainable and more attractive to capital providers and would-be acquirers. You do not need to put out the ‘For Sale’ sign or even have the intention of selling in the near-term, but what you have done is introduce a management discipline and responsiveness that will allow you to operate proactively, not reactively, in building your business. The less uncertainty and the fewer questions, the less your earnings will be discounted for risk, both real and perceived.
To take this discussion out of the realm of generalities, here are 7 strategies that will help make your business more valuable:
1 – Build and retain a deep management team – It sounds cliché, but it really does all start with people. There is no substitute for talented people working together in an environment built with trust. If selling is your objective, a strong management team that can execute a transaction and ensure continuity through a transition is vital. To align interests, it is important to incorporate retention bonuses and equity compensation for key people to reflect how important they have been to the business’s success and to help reduce the risk of underperformance post-sale.
2 – Focus on earnings – both quality and recurring – I know, what a revelation on my part. This is clearly an obvious point, but one worth briefly expanding on. No matter the economic cycle or market climate, profitable companies are always desirable, but astute buyers or investors will want a closer look under the hood to get a sense of the quality and replicability of the earnings. If you can provide visibility to the marketplace that your business is generating core, recurring revenue that is not one-time in nature, you’ve given more credence to those future cash flows. With some sophisticated buyers, they may ask for a quality of earnings study to be performed so they can ascertain the sustainability and accuracy of historical performance and the likelihood of future projections.
3 – Mitigate concentrations – Plainly said, concentrations, both in the form of customers and revenue streams, introduce more risk to a business. While it is difficult to turn away business or forgo expanding a customer relationship, becoming overly reliant on any one source adds to the risk quotient of a company and thereby is potentially harmful to value. Maintaining a diverse customer roster, where no one relationship accounts for more than 10% of total sales, is a check in the right box (although we understand reality may dictate otherwise).
4 – Explore markets and niches that are scalable – One of the more popular questions that investors have centers on the size of the opportunity. How big is the market? What is the size of the opportunity? If you can articulate that your company can effectively penetrate a small piece of a big market, the ability to meet growth expectations becomes more believable/achievable in the minds of investors or acquirers as opposed to needing a dominant market share.
5 – Maintain a strong financial foundation – There are an assortment of actions on this front, all of them important. #1 action item is to maintain your financials on an accrual basis (hopefully in accordance with GAAP, if feasible). Having your annual numbers at least compiled or reviewed by a CPA firm is a good start and a worthy expense. Running your financials through a 3rd party review helps in several regards, chiefly it provides confidence in their accuracy, and it makes it easier for buyers to compare and assimilate your numbers to theirs (banks like this too). #2 pertains to managing your capital. Capital is king as they say and managing it actively is paramount. Try not to get out of balance from a debt to capital standpoint as atypical capital structures relative to industry norms can be a red flag on value (irrespective if you can service the debt cost). Making sure you have additional capacity in the form of a revolver or line of credit is smart business as well. Lastly, #3 pertains to developing key performance metrics that can be surveyed routinely on a management dashboard or tool of the like. KPIs, or key performance indicators, are helpful to judge progress over time both internally and to pre-established industry/peer benchmarks.
6 – Leverage your uniqueness – This can be tangible or intangible, but there are products or services that can differentiate you from the competition. There is an axiom that it is cheaper to buy than to build. That is not to say you would sell to a strategic or private equity buyer on the cheap, but rather it is hard to penetrate an area where an established business is already performing well. If you have domain expertise, pound the drum and let the marketplace know. Same applies if you have a unique ability to innovate and commercialize. As mentioned in the first line, it is all about differentiation, which can lead to premiums on value being assigned.
7 – Focus on the blocking & tackling items – This is more or less a catch all for “minding the shop” and managing operations tightly and efficiently. An efficient platform makes due diligence much smoother and less risky. Is all of your IP secured and documented? Have you levered the right IT to help with communications and sales functions? Is your advisor team populated with experienced tax, accounting, legal, and finance professionals? Have you managed your vendors for expense saves and redundancies? There is obviously a myriad of other strategies, general and industry-specific, that would assist in making your business more valuable. Covering all would not be plausible, but it all comes back to understanding and identifying the key addressable areas of your Company that move the needle.
In assessing the value of a company, there is a lot of math and “science” that goes into it, but there is also some art. There is always going to be some embedded judgement and interpretation about future performance and the ability to capture opportunity. Whether you intend to transition your business some day or retain it for employees or future generations, the more risk you can strip out of your business while maintaining as many strategic options as possible will only enhance the value.
Chief Operating Officer
The Baldwin & Clarke Companies
About the author:
Peter is the Chief Operating Officer of The Baldwin & Clarke Companies and a Senior Associate with Baldwin & Clarke’s investment banking practice. Peter spent over 10 years as a financial analyst in the private equity industry space before joining Baldwin & Clarke to further support the firm’s capabilities working with entrepreneurial clients.