In the current environment of historically low interest rates, rising surplus cash balances held by corporates and record levels of private equity capital, it is an incredibly attractive time to sell a business. With closely held middle-market companies trading hands at premium valuations, many business owners are considering whether now is the right time to sell. While the decision to sell is complex and requires careful consideration, a key question for business owners is how to maximize value in a sale. The answer is multifaceted, as many factors drive value, such as size, profitability, growth potential, market conditions and industry dynamics, to name a few – but ultimately, there are no “silver bullets” or shortcuts. The best way to maximize value in a sale is to take a long-term approach to building value in the business now. This strategy begins well in advance of a transaction and is rooted in basic business-building initiatives, which include: (1) implementing structure, (2) investing in the team, (3) planning for the future, (4) understanding the key value drivers and (5) engaging with advisors. These practical steps are simple and straightforward but are nonetheless frequently overlooked by owners immersed in the day-to-day operations of their business. Effectively implementing these principles will create greater intrinsic value in the business today and ultimately serve as the foundation to maximize value in an eventual sale transaction.
Standardized processes and systems enable businesses to replicate success on an ongoing basis and to scale effectively. Most private companies, however, are built from the ground up and tend to be driven more by founder instincts than by processes and systems infrastructure. As a private company develops, investment in organizational infrastructure will support the creation of repeatable processes and procedures that can be transitioned under new ownership. Examples of business systems that enhance value include human resource management, inventory and fixed asset control, product or service quality control and customer relationship management. These systems are important, as they convert intangible intellectual capital into knowledge assets and help reduce business risk.
A consistent area of weakness with most small and medium-sized companies – and as a result, one of the most common hurdles during potential transactions – is a lack of reliable financial reporting and organizational record keeping. Having audited or reviewed financial statements prepared by a certified public accountant (CPA) results in increased credibility with lenders, insurance companies and other key stakeholders as well as potential investors and buyers; typically, companies with CPA-reviewed financial statements and well-organized records are better managed and more profitable. In the context of a sale transaction, accurate and organized financial records facilitate buyer due diligence, help maintain deal momentum, accelerate the transaction timeline and enable management to focus on the performance of the business and not get too distracted by the sale process.
Investing in the Team
Entrepreneurs have the tendency to run and grow their businesses with a very small team of critical decision-makers, which causes the growth trajectories of many businesses to plateau. While owners are ultimately responsible for making tough calls, they should build a strong bench of managers who can one day make key decisions and drive the business forward under new ownership – something that is particularly important to financial sponsors. Training, motivating and empowering employees reduces the burden on the owner on a daily basis and creates a culture where employees are engaged and productive. As counterintuitive as it may seem, over time business owners should strive to pass on day-to-day responsibilities to other team members and make themselves redundant so they can eventually walk away from the business without affecting its value upon sale. Building a strong management team and investing in talent enhances value by reducing the perceived risk of owner dependency and increasing the universe of potential acquirers.
Planning for the Future
Buyers pay for the future prospects of a business, not for past performance – although historical growth provides comfort about the firm’s future viability. Management teams of leading companies do not merely operate day to day; rather, they have a long-term vision of the company’s value proposition and position in the market, which manifests itself in a growth plan and a financial projection model that is used to track performance. Creating and continually reviewing a formal plan that includes measurable goals and milestones for the coming years helps provide discipline in managing and growing the business. When it comes time to sell, buyers will focus on the company’s projected revenues and earnings – and a well-constructed strategic plan will chart the vision for the business, its growth potential and how it will be achieved. The existence of a strategic plan conveys a higher level of sophistication and credibility of the management team.
Given that owners generally have a significant portion of their net worth tied up in the business, a personal plan should be developed in alignment with the business plan. The plan should contemplate an owner’s risk tolerance, retirement objectives, estate management and even health, among other things. Personal planning is particularly important when there are multiple owners who may have divergent goals. An early discussion will bring concerns to light and enable owners to align personal goals and objectives in advance of a liquidity event.
Understanding the Key Value Drivers
Owners tend to rely on gut feel, anecdotal evidence or an abstract valuation multiple when ascribing a value to their company. While valuing a private company can be difficult, this oversimplified approach prevents owners from identifying the key drivers of the business that unlock value – attributes that distinguish successful companies and set them apart from the competition. In reality, valuation is more nuanced and begins with the identification and careful examination of the critical factors driving value, such as revenue size and stability, profitability, market share, growth potential, customer retention, management team depth and barriers to entry, among others. The valuation process also includes an assessment of the key business risks, such as product and customer concentration and supplier dependency. Routinely updating the valuation provides a framework for business owners to periodically benchmark how strategies and tactics are affecting the value of the business and proactively change course as needed.
The key value drivers of a business are central components of the roadmap for marketing a business to potential buyers in a sale process. An owner’s solid understanding of these factors helps advisors more effectively articulate them to buyers and focus on creating a competitive dynamic that delivers a premium price.
More fundamentally, understanding the business’s value is important in determining whether or not to sell. Too many owners have an unrealistic expectation of value and end up wasting a lot of time and energy running a futile sale process. Knowing the value of the business is also essential in order to determine whether or not personal financial goals can be achieved through proper estate planning strategies. For example, the initial valuation will often be the lowest. This first valuation will be a critical tool for a business owner to assess and implement strategies to enhance and propel value drivers, but it is often also the best time to utilize gifting strategies and move interest in the business down to the owner’s next generation at a significantly reduced gift tax cost to the owner. Low valuations are therefore an excellent opportunity to do some strategic planning, both from a business perspective as well as an estate planning one.
Engaging with Advisors
Selling a business is a complex, time-consuming and distracting process. Most owners have limited experience in business sale transactions and are better served working with experienced transaction advisors. As opposed to engaging advisors in a “just in time” manner, best practice is to assemble a multidisciplinary team of advisors – including specialists in law, corporate finance, accounting, taxation and wealth management – well in advance of a transaction. Engaging with these advisors long before the actual sale enables business owners to build a rapport and level of trust before embarking on what is arguably one of their most important life events. A team of skilled advisors can offer valuable, objective advice throughout the life of the business – helping owners navigate legal, financial and operational challenges and take measured risks to grow the company.
As owners approach a point when a sale may make sense, well-established, trusting relationships with advisors prove vital in preparing and planning for the sale process. As opposed to selecting an advisor that is a new acquaintance, business owners can focus on important presale planning steps and transactional issues. During the execution of the transaction, the advisors’ familiarity with the business and relationships with the owner enable them to more effectively drive the process and structure a transaction that best achieves the owner’s objectives.
The steps to enhancing the value of a business and preparing it for an ownership transition are relatively straightforward but require discipline and time – generally years, not months – to implement and ensure that the benefits are fully realized. Through proactive business building and thoughtful planning and preparation well in advance of a transaction, a business owner will build a fundamentally stronger, more valuable company that is well positioned to maximize value when the time is right to sell.
The Corporate Advisory Group (CAG) is dedicated to building and expanding relationships with clients and prospects of Brown Brothers Harriman Private Banking through an objective, long-term corporate finance dialogue. CAG operates outside of the traditional transaction-focused, success fee-based investment banking model. As a result, CAG is able to approach clients’ unique needs without bias for any particular outcome and provide advice to best help clients achieve their business and personal goals and objectives.