10 Risks Affecting Business Value in Small Companies

SaaS

For most entrepreneurs, their own companies are, by far, their most significant single investments. To achieve the highest company value in a potential company sale, every shareholder should have a basic understanding of which factors cause company value to fall. Equipped with this knowledge, the entrepreneur can act long before a planned company sale to minimize or eliminate factors that reduce the company’s value. Following are the ten most common factors that cause the company value to fall and the countermeasures necessary for corrective action.

Unplanned Company Sale

By far, the most costly mistake a business owner can make is not preparing for the company sale. Those who sell in haste and under pressure are very likely to see a low enterprise value. To ward off the type of catastrophe, plan and implement measures at least one year–even better, three years–before selling the company. Engage a professional M&A advisor to develop a comprehensive plan to introduce value-adding measures and minimize or eliminate negative aspects, laying the foundation for a high company valuation when selling.

Related: Ways to Grow Enterprise Value. 

One Buyer Only

If you haven’t spoken to many potential buyers, you don’t know the alternatives and always have an inferior negotiating position. Limiting the field to only one buyer is the second most costly mistake sellers make. This happens when a buyer approaches the seller or talks to a company known for many years. Another case that frequently occurs in M&A practice is one’s lawyer or tax advisor/auditor doing the long-standing customer a favor and referring just one potential buyer. Regardless of how this “only one buyer” case comes about, we can rely on our many years of experience as M&A consultants to say that the sale of the company–should it come about at all–will always take place below value in such a case. We recommend hiring a professional M&A advisor to carry out an active sales process to get you the best price achievable on the market at that time. The following statement applies:

Identify the Right Buyer

This step is extremely important because you can lose a lot of time with unsuitable candidates. First of all, it should be clear what an ideal corporate buyer should bring:

  • The buyer needs to know how to run a business. This relates to social leadership skills and entrepreneurial management skills.
  • The buyer must be ready and willing to familiarize himself with a new subject. Ideally, the company’s future new management will already have the necessary industry knowledge.
  • The buyer must have the necessary financing capital. Of course, consider that the seller could also grant a seller loan and, if necessary, realize other funding opportunities.

How do I find out at an early stage whether a potential company successor meets these requirements? Begin with a telephone conversation and ask questions relating to the prospective buyer’s background, qualifications, interest, and funding. The seller needs to know whether this prospective buyer means business and is suitable to avoid negotiations with unsuitable candidates, which could cost half a year to a year of time and effort.

Surprises

Our experience shows that sellers who do not have an M&A adviser by their side surprise buyers with unexpected things in the sales process. As a rule, these are not positive surprises but negative ones (e.g., sales below plan, EBIT below plan, termination of essential customers, termination of important employees). As a company seller, avoid negative surprises throughout the M&A process. Consistently deliver what you promise because every negative surprise has a corresponding effect on the company’s value. With every negative surprise, the buyer’s doubts about your seriousness and professionalism increase.

Our experience proves that buyers can only put up with a few negative surprises before they quickly abandon the M&A process. Our advice is to reveal weaknesses and negative aspects proactively and early in the discussions with potential buyers. Be candid. Nothing is more unfavorable for the seller than when the buyer has to discover the negatives himself.

Neglecting Day-to-Day Business

Another common and costly mistake sellers make too much focus on the sales process regarding time and content. As a result, the operational business suffers. Especially in the process of a company sale, the business operation remain the primary focus, and the company should exceed the budgeted figures the seller has expressed to buyers. Every weakness or even a slump in business operation reduces the company value many times over or leads to the breaking off of discussions with potential buyers. Here, too, a professional M&A advisor allows the seller to concentrate on the company’s day-to-day business.

Customer Concentration & One-Time Sales

Every buyer is concerned about the loss of customers after a takeover. For this reason, a company to be sold should, if possible, generate no more than 10 percent of sales or profits from any single customer. The best solution is to diversify the customer base long before entering into selling the company. Wherever possible, long-term contracts should be concluded with customers. Do not include “change of control” clauses in customer contracts, enabling a critically vital customer to terminate the contract if the ownership structure changes. The more stable the customer relationships and the higher the proportion of recurring sales, the more secure an M&A transaction is from the buyer’s point of view–and the enterprise value of the company to be sold increases.

No Strong Management Team

Buyers are looking for companies that will function smoothly after a takeover and implement planned growth without the seller’s involvement. Buyers, therefore, find it difficult to justify a high purchase price if the seller leaves the company at short notice after a sale. The thinner the company’s management to be sold or the more the company to be sold depends on the founder and seller since all-important customer and employee relationships and essential know-how lie with the founder. For this reason, sellers should make the company independent of themselves long before a planned sale and build up a professional first and second management level.

Poorly Prepared Financial Data

Poorly prepared financial data indicate a lack of quality awareness and represent an increased risk to buyers. Therefore, make sure that the preparation and level of detail of your financial data meet today’s requirements for professional accounting. Historical data is an essential criterion for every buyer when assessing the target company’s financials. The more precise assumptions can be made, and more closely they match the history, the more credible the planning–and the higher the company valuation.

Poorly Prepared Legal Documents

Complete, professional preparation of all relevant contracts is an essential sign of professional management. Companies with weaknesses in brand protection, contracts with customers and suppliers, etc., pose an increased risk for potential buyers. Long-term rental contracts and other contracts with long notice periods and contracts with exclusivity (e.g., exclusive license agreements) prevent potential buyers from expanding the company. Ensure that your contracts are set up professionally and that there are no significant risks in the contracts from the perspective of a third party.

Lack of Confidentiality

Sellers who do not hire an M&A advisor run a high risk that competitors, customers, or employees will find out about the company’s planned sale. The longer the sales process takes, the greater the risk that competitors will poach employees and customers. Every loss of customers and employees causes the company’s value to decline. A professional M&A advisor will carry out the sales process in strict confidence.

Inexperienced M&A Team

We see it almost every day: an inexperienced seller meets a professional M&A team representing the buyer’s interests. Such a buyer M&A team usually consists of an experienced M&A advisor, a team of lawyers with many years of experience in M&A contracts, and auditors and tax advisors experienced in M&A matters. If a salesperson and his team of long-time tax consultants and trusted lawyers meet such a team representing the buyer, then they can only lose. “Lose” not only refers to a lower enterprise value but also unfavorable contractual clauses and tax consequences. An experienced M&A team on the buyer’s side will leave no stone unturned after due diligence to negotiate the purchase price downward and to include contractual clauses unfavorable for the seller. In such cases, the seller’s inexperienced M&A team reacts emotionally and takes every “attack” personally, which often leads to the severance of talks and negotiations.

EBIT is only one of many factors crucial to achieving high company value. In addition to EBIT, professional preparation of documents and professional implementation of the sales process by professionals are required to complete the sale and achieve a high company valuation. Avoid the 10 points mentioned above, and you are guaranteed to generate higher sales revenue and gain the upper hand in sales negotiations.

New call-to-action

Author Summary

Alan Lambert

Alan Lambert

Related Posts