For many years I have written that a company’s value during a sale process is determined primarily by three variables: Size of the company, growth of the company, and profits of the company. Of course, that is overly simplistic. Many other factors influence the value of a company. Several examples are: the industry in which the company competes, the overall M&A market and current access to debt, and the barriers to entry that the company enjoys. But there are four additional factors within management’s control that can influence greatly a company’s valuation – positively or negatively – at the time of a sale:
- A strategic plan articulating the growth for the ensuing five years;
- An Audit and/or seller’s Quality of Earnings report;
- A strong bench of management talent;
- A concentration of customers or suppliers.
FACTOR 1: A fully developed strategic plan articulates both a vision and a road map to growth for the next several years. Buyers buy the future. If you can articulate how and why the future will be brighter than the immediate past, then the you have done the buyer’s work for them. This plan should include:
- Key reasons and actions why and how growth is achievable;
- Targeted audiences and why they are desirable and additive to the current business;
- Detailed budgets – especially around sales gains – that can be verified by evidence.
The evidence cited should include key facts and anticipated spending for prospecting, reactivation and customer development. Teach the prospective buyer how to grow the business and then one has the possibility of sharing the spoils of that growth.
FACTOR 2: In addition to giving the buyer a road map for the future, explain the past. An Audit and/or Quality of Earnings report– along with remedial work on any less than ideal accounting practices – are necessary ways to teach the buyer about the business. Accounting is the foundation upon which the story of the business’ profitability rests. If the foundation is weak and shifting, trust in the numbers is lost. I have seen valuations change by significant amounts – from 20% to “we’re no longer interested” – because the numbers became suspect. An audit, by a reputable, relatively large firm is a stamp of approval that the numbers are solid. Furthermore, a sell-side Quality of Earnings report does the buyer’s work for them and puts the seller’s spin on adjustments. Most entrepreneurs know their business inside and out, and the numbers are just a score keeping. However, scores need to be kept accurately. Put yourself in the shoes of a buyer. Whom would you believe more? The selling owner saying profits were $x or a government regulated outside CPA saying the profits were $y?
FACTOR 3: In addition to telling the story, both past and future, a company needs a team to carry out the plan. Ideally, there is a strong bench with great teamwork that is capable even if the CEO/owner leaves the business. Though it isn’t pretty, there is always the question, ‘What if this person gets hit by a bus (or wins the lottery)?” While some buyers don’t care – if the company is being folded into another company, or the private equity buyer has a management team ready to go, the concentration of knowledge, experience and ability in single individuals presents risks to a buyer. Risk is another word for “Less money to the seller”.
FACTOR 4: Other factors that present risks to the buyer are the concentration of the source of supply and/or customers. If one customer represents 30% of sales or more, then the most important question becomes: “What if that customer lowers its purchases?” The same type of question can be asked if a supplier represents too much of the cost of goods or valuable service. Long term contracts, readily available alternative sources of supply, and other solutions can dampen the risk of concentrations, but the risk is still there. And, what did I say about risk? – Less money to the seller.
There are methods to enhance the value of a company beyond its growth, profits and size. Among the actions one can take are: articulating a vision and plan; having the accounting audited regularly by a reputable CPA; building and strengthening the management team; and lessening any concentration of supply or sales.