- Business owners can gain great negotiating power if they maximize the value of their business long before taking it to market.
- Knowing what drives buyers’ perceptions of value is critical to a successful exit.
- There are at least 11 ways owners can design an organization that yields higher value at exit.
Business Value: How Can Business Owner’s Maximize it?
Have you ever wondered why prospective buyers retract from their offer to purchase small privately-owned companies after conducting a due-diligence review and thorough company analysis?
Most business owners have unrealistically high expectations when it comes to selling their business. When asked about their business value, they have a vague idea instead of a tangible number.
Small company owners often do not even know the tentative amount they will need to fund their retirement after exiting the business. And they’re not even aware of the steps that could improve their business value and lead them to a successful exit.
Generally, owners have 70 to 90% of their net worth tied up in their company, making them dependent on the sale of their business for retirement funds.
Even if the purpose for exit is not retirement, just about every owner wants to maximize the selling price of their company. They need to boost the company’s value to realize profit enough after deducting fees and taxes.
All business owners aim to get maximum value while selling their businesses; however, they fail to adequately plan for the amount of effort and time required to sell a business. They often make the mistake of trying to sell their businesses before they have maximized their enterprise value.
11 Ways Owners Can Maximize the Value of their Business Before the Sale.
Business owners can gain great negotiating power by maximizing the value of their business before taking it to the market. The key to improving business value is to understand what buyers look for in a company. Below are some steps that all business owners should take before going to market.
#1 – Identify Areas for Improvement
A sound transition plan helps business owners realize their exit goals and the tentative time-in-hand for getting their company ready for a sale. They can utilize this time before taking the company to market to maximize the value of their company.
#2 – Get Assistance from Professionals
Business owners should hire the services of an accredited valuation firm (or leverage a platform like Value Scout) and obtain an independent professional valuation of their business. They can also seek guidance from an objective business adviser, who can reveal the strengths and weaknesses of their business by conducting appropriate assessments and audits of systems and procedures.
By identifying the value drivers for their business, owners can increase the value of their companies and ultimately their sale price dramatically.
Business owners should prioritize the weak value drivers of their company as revealed by those assessments and work towards improving them.
#3 – Develop a Stable Management Team
Buyers and investors alike seek businesses that have management teams to effectively carry out sales, marketing, and product or service delivery.
When owners are involved heavily in daily operations that are key to the business’s health, buyers see it as a substantial risk that will negatively affect value during a valuation of the company. On the contrary, a strong management team handling critical matters independently will yield a high value to a potential buyer.
Also, business owners should ensure that the workforce is skilled, efficient, and loyal. Key employees can positively impact the value of a company, especially when buyers are interested in sourcing specific skill sets to enhance their existing business.
#4 – Clean Up Financial Records
Companies usually fail due diligence when prospective buyers or lenders find that their financial statements appear sloppy or unreliable. Business owners need to take extra care that their book of accounts is error-free, accurate, and reliable.
For instance, if a business’s revenue exceeds $10 million, owners should consider obtaining audited financials. Audited financials are done following GAAP, which ensures quality, accurateness, and professionalism. Business owners can also opt for externally reviewed financials, providing a higher degree of quality than internal financials.
#5 – Ensure a Stable Business Location
In some businesses (like retail), location plays a pivotal factor in their market value. A change of location after the acquisition or merger could adversely impact the revenue and profits of the organization.
Even when the companies are in the manufacturing or wholesale business, likely, the key employees reside nearby, and changing locations may push loyal employees to look elsewhere — leading to potential risk or losses for investors.
Acquiring companies consider firms with unstable facilities for operations to be risky. Business owners seeking to maximize the value of their business should ensure the stability of the business location for at least three to five years after the sale.
They can explore extended lease options to remove uncertainty without reducing the value of their business. Such arrangements give the business owners the flexibility and not the obligation to extend the lease beyond the current term.
#6 – Provide Clarity of Future Growth in Earnings and Cash Flows
Investors are not just interested in a company’s records of earnings, cash flow, and growth. Still, they also seek to purchase a profitable business showing clear indications of progress in the future. Business owners looking to maximize the value of their organization need to have a written plan describing how their company can achieve future growth.
The document should have clear indications of which factors will drive future earnings. They could include new product lines, expanding the augmented territory, increasing manufacturing capacity, industry dynamics, etc.
#7 – Develop Strong Operating Systems
The strength of a company’s systems, processes, and procedures plays a vital role in improving the value of a business. By planning for the sale early, owners can work on their systems and make them robust enough to pass the assessment that prospective investors will conduct.
Business owners must detach from the procedures and develop them so that their long absence does not impact the efficiency of the systems. Also, owners should empower the management team to handle difficult situations and obstacles without their input.
Business owners can leverage their solid operating systems in potentially negotiating a higher asking price during the sale of their business.
#8 – Ensure Clear Bifurcation of Personal and Business Expenses
It is not uncommon for private company owners to include their expenses in the books of the business. However, during the due diligence process, investors consider an abundance of add-backs to earnings a risk.
Uncertainties in financial records can bring the value of a company down during negotiations. To avoid such situations, business owners should proactively minimize personal expenses on their book of accounts to build credibility for their financials.
#9 – Develop Solid Vendor Relationships
If the pandemic has taught us anything, it’s that a business dependent on one supplier is vulnerable to significant raw material shortages and disruptions in supply. As such, investors consider having a high reliance on a sole supplier risky, which detracts from value.
On the contrary, a company with a diversified supply chain is seen as a positive factor from an investor’s point of view. Having multiple sources of suppliers of essential inventory and raw materials stabilizes a business’s supply chain.
#10 – Reduce Customer Concentration Issues
When investors value a business, they factor in the risk associated with customer concentration. Having high customer concentration (several large clients that drive a preponderance of revenue) can lead to severe dips in revenue if a customer goes in a different direction.
Potential investors see large revenue concentration (20% to 25% or higher) as a red flag. Business owners should actively work to diversify their customer base to combat this risk as much as possible.
#11 – Cultivate a Strong Market Reputation
A bad reputation in the marketplace is a significant value detractor. Buyers or investors keep themselves knowing what customers think of a particular company and its products and services.
Potential buyers will deploy multiple techniques to unearth the actual condition – they review websites that provide customer feedback, quietly gather information from business circles, research events, tradeshows, and seek out input from customers and suppliers.
While preparing to take the company to market, owners should build a good reputation in the marketplace. They should listen to what their customers are saying and make changes accordingly in their products and services’ quality, delivery, and pricing. It can help them significantly improve the value of the business.
The Most Successful Owners Plan for Value Creation
Maximizing the value of the business is possible if owners put in intentional and consistent efforts to do so. On average, a company needs two to three years to improve value drivers and do what’s necessary to drive incremental value for the business.
Improving your company’s value drivers ensures that the company passes through even the most rigorous audits, assessments, and due diligence processes of potential buyers. More importantly, such efforts pay off in the form of a larger sale price and an increase in the transfer of cash to the owners on the sale of their company.
So, companies considering going to the market should plan well in advance to give themselves sufficient time to prepare and enhance the value of their business and realize the maximum possible sale price.
For a deeper dive on valuation, sign up for our valuation course within the Guidon community.