Jeffrey A. Mazer, CFA, JD
We are in the middle of a significant intergenerational transfer of assets. Baby boomer business owners are reaching their 60s and 70s, and seeking to retire. According to a 2014 article in theHarvard Business Review, four million privately-held businesses were forecast to changeowners over the next two decades. Of these, 75% of business owners had no exit plan in place.
For many of these owners, growing and operating their businesses has been one of the focal points of their lives, and is a principal part of the wealth they need for retirement. Not having an exit plan in place risks reducing the wealth that they have worked so hard to create.
What can a business owner do to ensure that he or she receives maximum value for their business in a sale process? Ultimately, a buyer is most interested in the ability of the acquired business to generate the cash flow for which they are paying. Any factor that makes it less likely that the business will generate that return will reduce the value a buyer is willing to pay.
Building a solid exit plan can take several years, and business owners ideally should start planning for a sale 3-5 years before they wish to retire. There are numerous factors that can positively or negatively affect value. Advance planning for these issues can yield benefits when the time comes for a sale.
Deep management team.
For many small businesses, the business owner maintains all of the important relationships with key customers and suppliers. Unless the seller is willing to work with the business for a extended period of time after the sale, a management team needs to be in place that can smoothly transition those relationships to a new buyer. The risk of losing important sources of revenue or supply can significantly reduce a purchase price or lead to a failed transaction.
Business buyers will seek to operate as efficiently as possible to obtain the maximum value from the business. If a buyer thinks there’s a risk that planned efficiencies and cost savings are not achievable, they will adjust the purchase price downward. Implementing efficiencies and cost savings before a sale reduce that risk and justifies a higher valuation.
Broad customer base.
For most businesses, revenue derived from sales to customers creates most of the value. In the case of a business with a concentrated customer base, the owner should seek to broaden the customer base and reduce reliance on those key customers. Multiple sources of revenue are always going to lead to a higher valuation. If the loss of one or two key customers will have a major impact on cash flow, a buyer will reduce the purchase price to offset the additional risk.
Quality of financial reports and systems.
Buyers need to rely on accurate financial statements and systems to assess the financial performance of a business. If the seller’s financials can’t be relied on, a buyer will adjust the purchase price downward because of the additional risk or cancel the transaction completely. Similarly, buyers prefer to rely on seller financial statements that are audited by a high-quality, independent, auditing firm. Not being able to provide comprehensive and professionally-prepared statements to a buyerwill reduce the value of the company. Even statements that are only reviewed or compiled by an accounting firm are better than statements without outside review.
A company that has a track record of sales growth will be valued higher than one that has flat or declining growth. Past sales growth shows a buyer how they can also grow the business after the sale.
Create a company that buyers want.
Industry multiples are often used as one measure of the value of a company, and are almost always considered as part of a standard business valuation. By focusing resources on growing a line of business that has higher multiples, a company can justify a higher value, even while their customer base remains the same. A business in the computer industry, for example, will tend to sell at a higher multiple than a company in the consumer electronics industry, even though their markets and their customers are similar.
One more thing . . .
Selling a business is, for many owners, the culmination of a life’s work. It’s worth the time, planning and expense to get it right. Having knowledgeable financial advisors and attorneys can make a big difference.