Are you thinking about the future?
As your business matures, it is never too early to start thinking about what it’s worth and how you plan to exit. Even as you are trying to grow and manage day-to-day operational decisions, it is useful to know what key variables will impact value, and what you can to do increase the value when you decide to sell.
To start, it’s helpful to understand how a business is valued. It is generally determined by two key factors: Cash flow and the multiple.
- The cash flow of your business is measured by the profit, plus or minus a number of ‘normalizing adjustments.’ Typical adjustments include owner’s compensation, depreciation, and other expenses that have a highly variable or somewhat discretionary element.
- The multiple is even more important. Of course, if you can double your bottom line, the value of your business increases — so the obvious advice is to focus on sales and profits. But there are other key value drivers that influence the multiple, regardless of the size of your business:
Some other things to consider include:
Successor: Don’t just wait for buyers to come to you. Invest in the legwork to identify, qualify, and prepare potential successors. This may include redefining roles and responsibilities, training, monitoring, and implementing dispute resolution mechanisms. Determine ‘optimal buyers’ and their motivations. The strategic acquisition of specialized equipment or intellectual property, for instance, may be of higher value to some buyers than others. Consider your marketing strategy as you approach them.
Management: Do you effectively delegate? Do you have quality ‘bench strength?’ Can you personally take a two-month holiday without any adverse effects on the business? If the answer to any of those three questions is no, the value of the business is locked up in you, and it will be hard to sell or transition your business at all.
Finance: A common mistake that erodes value is when the owner clouds the bottom line with ‘personal’ expenses. Your business is valued based on a multiple of sustainable income. You need to prove your business makes a good profit and can thrive without you. If you are funneling your personal expenses through your business (nudge, nudge), consider this: Doing so saves you perhaps 12 per cent tax. That means paying for $8 in personal expense saves you one dollar in tax, but — assuming a conservative multiplier of three-times your bottom line — could cost you $24 when you sell.
Revenue mix: Do you have a customer that disproportionally accounts for a large portion of your sales? Buyers prefer a diversified customer base. Unless you have solid contracts in place with your larger clients, the value of your business may be less. Personal guarantees and long-term track records aren’t enough.
What you do and how you do it: Companies that provide a unique product or service, or that employ a unique process, are more appealing than commodity businesses where there is greater competition. Pay attention to where your sales fall along the product life cycle as well. If you are overly reliant on sales from ‘dated’ technology, your primary business is exposed to elevated risk and consequently has lesser value.
Tips for transition
Succession planning isn’t always a fun exercise — especially if you’ve built the business from scratch. Actually parting with your company can be even harder. Many owners start with an inflated idea of what their business is truly worth, and can be left feeling dejected.
There are a few things you can do, though, to make the experience less stressful:
- Plan early — 10 years out isn’t too long. Many adjustments to managerial and financial aspects of your business will take time to put in place, but certain tax savings strategies may take even longer. You can save significant dollars if you plan ahead at least two years before you sell.
- Review the legal structure of your company and its ownership. Try to ensure the corporation is ‘clean,’ ready to sell, and positioned to maximize the ability to sell shares and utilize your personal capital gains exemptions.
- Be prepared to leave a small amount of money in the company (i.e., vendor financing) as it transitions. Some buyers see this as reassurance they will have your cooperation as the new ownership takes the reigns.
- Consider alternative sales options. Employee ownership is becoming a popular vehicle that may allow you to keep the ‘spirit’ of the organization completely intact.
- Finally, start thinking broader. Understand the full range of succession planning issues — on the business side, as well as the transaction side. While the transaction pieces are critical, the longer-term business issues are where you will really make the difference in the ultimate success of the transition.