Two-thirds of American businesses will transfer ownership within the next decade, according to recent research from Pepperdine University. Amidst this generational shift, owners who invest the time and energy to optimize their companies before putting it up for sale are more likely to stand out from the crowd and reap a higher price from a potential transaction. No phase of the business sale process should be glossed over, but today let’s explore why assessing and accelerating business value is vital to keeping a deal on track. We’ll also pinpoint action items to bolster pre-sale standing.
The danger of value gaps to business sales
After years of building and leading a successful company, owners often feel they have a solid handle on its value. Research shows that value gaps are among the top causes of deal breakdowns, so it is critical to test these assumptions with an independent, third-party valuation performed by a professional who is active in the transaction world. Peeling back the layers of a business allows owners to confront the reality of their operations and gain a deeper understanding where value is strong and where it may be vulnerable. Three key forces in business value as part of a sale are future cash flow, business risk and the transferability of value.
Action Item: Demonstrate consistent cash flow
Consistency and upward trends are key to cash flow. One successful year will not move the needle in terms of sale price, so owners should compile at least three to five years of annual cash flow data to give potential buyers a sense of the financial trends at play. Do not despair if some years are not as stellar as others; demonstrating a wider track record of dependable performance is more beneficial than one or two years that can be dismissed as outliers.
Cash flow in family owned or closely held businesses is often depressed due to discretionary expenses of the owner. While buyers generally overlook this circumstance, owners will benefit from proactively reducing these discretionary expenses, improving the quality of earnings as they prepare the business for sale. This will make the cash flow trend referenced above more representative of the true financial state of the company. Another worthwhile effort at this stage is to adjust earnings for non-recurring revenues or expenses.
Action Item: Invest in people, process and technology
During the evaluation process, several areas can raise red flags for buyers related to a company’s ongoing operations. The most common perceived risks are concentrated customers and/or suppliers, an older workforce and outdated technology or equipment. Having a single vendor supply the bulk of raw materials or one client make up the majority of the customer base leaves a company vulnerable if those relationships were to rupture. Key ways to mitigate these risks are broadening the pool of customers, developing a more robust supplier network and building multiple relationship points within each vendor.
Investing in the latest technology and updated equipment provides a measure of financial comfort to potential buyers, as they likely won’t be hit with a significant, immediate expense to upgrade soon after the transaction. Business owners should take stock of their workforce and infrastructure to ward off disruption from a competitor who can deliver the same product or service in a less expensive and more efficient manner.
Action Item: Detach owner as critical element of the business
Beyond high profitability and low controllable risk, the buyer has to perceive that it will be able to benefit from the purchase. This means the intangibles – essentially any portion of the purchase behind the hard assets – must be able to be passed on from seller to buyer. Even in the case of a business with terrific profitability, low reinvestment needs and a diversified customer base (all of which would suggest a traditionally high value), too much dependence on the owner’s knowledge base and relationships with key customers can negatively impact the business value. Taking steps early on to transition roles and responsibilities to other employees will support a sustainable business with transferable value.
RKL’s team of transaction advisors have decades of experience assisting owners not only in getting their companies ready for sale, but also supporting them even after the ink is dry on the agreement. Contact us today to find out how we can help boost your business sale prospects.
