The Impact of Value Drivers on Sale Price

Business experts may mention “Value Drivers” as if everyone knows what they are, how they work, and where their impact will be greatest. It can be difficult or frustrating to know that building business value is a frequent topic of discussion, but actually building value is sometimes easier said than done.

It may be the case that one business has buyers lined up willing to pay top dollar while another sits on the market for months or even years. What do buyers look for in a prospective business acquisition?

There are many opinions about which attributes or characteristics buyers seek, but here’s what we have observed: The characteristics buyers seek must exist before the sale process even begins, and it is your job as the owner to create value within your business prior to the sale. We call characteristics that impact value “Value Drivers.”

Look At Your Business Through A Buyer’s Eyes

To grasp the importance of Value Drivers when preparing to sell a business, owners must put themselves in the buyer’s shoes. Consider the following case study, which illustrates how a buyer might approach the search for effective Value Drivers.

The Alpha Company has earnings before interest, taxes, depreciation, and amortization (EBITDA) of $2 million, an owner who runs the business, and systems and processes that create growth. The Alpha Company does not have a true management team in place, and the owner generates a majority of its sales. The owner is the locus of the company, holding both the CEO and CFO positions. With such overwhelming responsibilities, the owner is burning-out quickly.

By comparison, the Beta Company has EBITDA of $2 million and a solid management team that runs the business, systems, and processes. The management team creates efficiencies within the business, and the owner vacations for six weeks a year.

If you were a buyer comparing these two companies, which factors would you consider more likely to lead to a successful acquisition? How much more would you pay for a business with a strong management team (one of the most important Value Drivers)? Would you be interested in buying a business whose management team (i.e., the owner) walks out when you walk in?

Experts in getting businesses sold understand that companies that lack strong Value Drivers also lack a strong pool of buyers. The buyers that do come to the table do not arrive with pockets full of cash.

The Most Common Value Drivers

Consider the following important Value Drivers common to all industries.

• A Stable and Motivated Management Team: If owners can wait a year to sell their businesses, they should consider an incentive compensation system that is either cash or stock based and rewards key employees based on how the company performs (usually measured by increases in pre-tax income). Sophisticated buyers know that with a solid management team in place, prospects are good for continued business success. Without a strong management team, it may be difficult to sell the business to a third party or transfer it to an insider.
• Operating Systems That Improve Cash Flow Sustainability: Operating systems include the computerized and manual procedures used in the business to generate its revenue and control expenses (i.e., create cash flow), as well as the methods used to track how customers are identified and how products or services are delivered. The establishment and documentation of standard business procedures and systems demonstrate to a buyer that the business can be maintained profitably after the sale.
• A Solid, Diversified Customer Base: Buyers typically look for a customer base in which no single client accounts for more than 10% of total sales. A diversified customer base helps insulate a company from the loss of any single customer. If the majority of an owner’s customer base is made up of only one or two good customers, the owner should consider reinvesting profits into additional capacity that will make developing a broader customer base possible.
• A Realistic Growth Strategy: Buyers tend to pay premium prices for companies with realistic strategies for growth. Even if an owner expects to retire tomorrow, it makes sense to have a written plan describing future growth and how that growth will be achieved based on industry dynamics; increased demand for the company’s products; new product lines; market plans; growth through acquisition; and expansion through augmenting territory, product lines, and manufacturing capacity. This properly communicated, detailed growth plan helps attract buyers.
• Effective Financial Controls: Financial controls are not only critical elements of business management but also safeguards for a company’s assets. Effective financial controls support the claim that a company is consistently profitable. The best way for owners to document that their companies have effective financial controls and that their historical financial statements are correct is through a certified audit or a verified financial statement from an established CPA firm.
• Stable and Improving Cash Flow: Ultimately, all Value Drivers contribute to stable and predictable cash flow. It is important that the company’s cash flow remains substantial and continues to grow, especially in the year or so preceding the sale of the business. Owners can begin increasing cash flow today by focusing on ways to operate their businesses more efficiently by increasing productivity and decreasing costs.

You can install these Value Drivers and better position your company to secure a premium price upon your exit with the help of a trained Exit Planning Advisor.

If you have any questions about increasing the value of your business prior to your exit, please contact us to discuss your particular situation. We can help you identify and strengthen the current Value Drivers in your business, install additional Value Drivers, and create a road map to meet your overall Exit Objectives. We also have resources that explain Value Drivers in more detail and can help you apply these concepts to your business.

Does Value-Building Equal Exit Planning?

Every day, we work with owners to build sustainable value in their companies. Some of these owners build value to make their companies more profitable, others build value with an eye on growth, while still others want to use systems that build value to become more organized. These are great reasons to build value, but we look at building value a little differently, because in Exit Planning, we take a longer view and help business owners prepare to exit their companies when they choose and for the amount of cash they desire.

Although building value is not the crux of Exit Planning, it is a necessary and principal part of every owner’s Exit Plan. In turn, Exit Planning provides the context for building value. In other words, building value serves many masters, the most important of which is allowing owners to reach their ultimate goal of converting their lives’ work into the post-business lives they desire.

When we talk about building value in the context of Exit Planning, we ask the following questions:

1. What is the company’s current value?
2. What value must the company achieve to enable its owner to reach his or her lifetime income and other Exit Objectives?
3. Which tactics can owners employ to close any gaps between today’s business value and the value they need upon exiting?
4. How can owners transfer business value most efficiently (in terms of taxes and otherwise)?

To answer these questions in an Exit Planning context, consider the case of Peter Daniels, a fictional business owner. Peter is 58 and married to Pam, who also is 58. He is the sole owner of Daniels Food Processing Inc. and has a salary of $250,000. His Exit Objectives are as follows.

• Exit at age 63 (five years from now).
• Post-exit income of $200,000 for 30 years. (Please note: Owners tend to underestimate the future amount of annual income they will want and need. In doing so, they set themselves up for a disappointing post-exit lifestyle. In Peter’s case, he used a financial planner to arrive at a realistic income goal.)

Peter has no specific successor in mind. Now, consider the status of Peter’s company, Daniels Food Processing Inc.

• Annual cash flow of $250,000
• Estimated current value of $1–1.25 million, as calculated by a business appraiser.

To finance the Daniels’s post-exit income needs, given the number of years they want income and their assumed rate-of-investment return (7%), Peter needs to sell his company for $3–3.5 million to net $2.5 million. Thus, Peter must increase the value of his company by at least $2 million if he is to exit on his terms.

In Peter’s case, the Two Million Dollar Question is “How can Peter increase the value of his company by $2 million over the next five years and thus close the gap between the business value he has and the business value he needs?”

1.  What is the company’s current value?
Based on an industry rule of thumb, Peter thought he knew his company’s current value. In Exit Planning, because the company’s current value is a cornerstone of the work to follow, guesses and assumptions about value are grossly inadequate. Owners must retain valuation experts to establish at least a thumbnail valuation to know what their companies are really worth.

2.  What value must the company achieve to enable its owner to reach his or her lifetime income and other Exit Objectives?
In creating an Exit Plan, owners quantify the amount they will need to support the post-exit lifestyle they desire. Usually, they work with a financial-planning professional to establish the “working assumptions” that Peter established above (life expectancy, the future value of non-business assets, and rates of return on investments). Owners also must ask and answer hard questions about how lavishly or simply their post-exit lifestyles will be. Without an accurate and realistic assessment of where an owner is and wants to be, it is difficult to develop and implement any plan.

3.    Which tactics can owners employ to close the gap between today’s business value and the value they need upon exit?
Only after determining the size of the gap between current and desired business value does it make sense for owners to decide what needs to be done to close it. Understanding how far one has to go within a specific time frame provides the context for achieving one’s goals. Without a time frame, most owners will not take the sustained action required to accomplish what is needed, instead pledging to plan right after “this crisis,” “this major project,” or “this busy season.” However, these pledges are rarely kept.

The time frame inherent in the gap analysis creates responsibility: It requires self-discipline, and each small step is subject to the accountability that we teach our children but fail to practice when it comes to Exit Planning. By using gap analysis as the foundation for Exit Planning, owners can identify and implement specific actions that will increase the value of their companies. While there are myriad value-building actions from which owners can choose, the most critical are those that enable a business to operate successfully without its owner’s involvement. These include the creation of a stable and highly skilled management team, understanding and using current financial information to track and alter company performance, and the installation of sustainable, organization-wide systems.

An Exit Plan also should include collecting, interpreting, and using the data necessary to track progress toward an owner’s goal. Tracking may include monthly, quarterly, and annual cash flow projections, as well as the creation of an annual business plan.

4.  How can owners transfer business value most efficiently (tax and otherwise)?
Good Exit Plans view value-building and all other activities through an income-tax lens. Owners use every legal strategy and tactic to minimize taxes while they earn money, grow value, and transfer that value. Because taxes skim off value that takes decades to create, it is far more effective to act with a grasp of current and future tax consequences. Owners should use knowledgeable advisors long before the eventual transfer of their companies in a way that limits the tax burden (as far as legally possible) for both the owner/seller and the buyer.
Exit Planning’s value-building tools can close the often significant gap between a company’s current and desired values. We are eager to help you figure out whether you are facing such a gap and if so, quantify it and help you close it.

If you’d like more information about how we can help you increase the value of your business in the context of planning your business exit, please contact us.

Knowing Business Value is a Very Good Place to Start

People don’t want to spend money on things they don’t need. So why would you need an estimate of your company’s value if you don’t expect to leave for several or many years? You may not if you fall into one of two groups:

• Owners who are sure that their business exits are more than 10 years away.
• Owners who are certain that the value of their companies is miniscule compared to what they will need upon sale or transfer.

However, many owners look to the value of their businesses as the chief source of liquidity for their post-exit lives. Owners intend to leave as soon as is feasible rather than when they are completely burned-out. Therefore, most owners need to know the value of their companies now so they can be smart about creating greater business value as quickly as possible.

Knowing the value of your business today is critical, whether you plan to leave your business tomorrow or in five years, for the following five reasons:

1.  An estimate of value establishes the starting line and distance to the finish.

An estimate of value tells owners where their unique race to their exits begins. The owner’s job, whether the company is worth $500,000 or $50 million, is to fill the gap between today’s value (the starting line) and the value he or she needs upon exiting (the finish line). Based on today’s value, an owner’s race to the finish line may be shorter, longer, or perhaps much longer than expected. Once owners know how far they and their businesses need to travel, they can begin to create timelines and implement actions to foster growth in business value.

2.  An estimate of value tests owners’ Exit Objectives.

An estimate of value helps owners determine whether their Exit Objectives are achievable. Let’s assume that an owner, Kate, decides that her finish line (i.e., financial objective) is to receive $7 million (after taxes) from the transfer of her business interest. Kate wants to complete her race in three years (timing objective). An estimate of value will tell her whether the distance between today’s value and the finish line is too great to reach in three years. If the growth rate is unrealistic for Kate’s business, she must either extend her timeline or lower her financial expectations.

3.  An estimate of value provides important tax information.

An estimate of value gives owners a basis on which to analyze the tax consequences of Exit Path alternatives. Once an owner chooses a path, the value estimate provides a basis for the owner’s tax-minimization efforts. Taxes can take a significant chunk out of a business’ sale price; therefore, the value of the company (i.e., what a buyer pays for it) usually must exceed the amount of money owners need to fund their post-exit lives. The size of that excess depends on how owners and their Exit Planning Advisors design their exits. Exit Planning, in turn, begins with knowing the company’s starting value and the distance to the finish line.

4.  An estimate of value gives owners a litmus test.

Knowing how much value they need to create to meet their objectives helps owners determine where they need to concentrate their time and efforts. Instead of growing value arbitrarily, dedication to a goal may enable owners to exit sooner than owners who do little or no planning, with the same amount of after-tax cash. Pursuing Exit Plan success always begins with a starting value.

5.  An estimate of value provides an objective basis for incentive plans.

As owners design incentive plans for key employees (e.g., stock-purchase, stock-bonus, and nonqualified deferred-compensation plans) to motivate them to increase the value of the company (so owners can work toward a successful exit), they must base these plans on an objective estimate of value. Owners and their employees need a current value (or starting line) on which they can rely confidently.

The Estimate of Value Is Not a Full-Blown Valuation!

We know you are thinking, “How much is this going to cost me?” However, we’re suggesting that you only need an estimate of value to establish a benchmark; you do not need the opinion of value, which might precede your transfer of ownership years from now. An estimate of value typically costs about half as much as a standard valuation opinion and is the basis for the later, complete valuation. However, it lacks the supporting information contained in a written opinion of value and is used for planning only. It cannot be relied upon for tax or other purposes.

Failure to Value

On some level, all owners recognize that they will leave their businesses someday. While you might not yet have a vision for the second half of your life, you must understand that exiting your company is likely to be the largest financial transaction of your life. Does it make sense to go into that transaction and the second part of your life without an objective understanding of your company’s value? An estimate of value can save precious time as you build value and pursue the exit of your dreams.

If you would like more information about the role of business valuation in Exit Planning, please contact us.

First Things First: Prioritize Your Objectives

“You’ve got to be very careful if you don’t know where you’re going, because you might not get there.” — Yogi Berra

It is not always easy to interpret Yogi. In this case, perhaps he is advising you to figure out just where you are headed in your business. As you near the time when you will leave behind the daily worries and stresses of business ownership, have you defined your successful exit? Do you know where “there” is, much less how to get there? Unless you set and prioritize your exit goals or objectives, you may have too many, or they might conflict, but in either case you may not make much headway.

The clearest example of a failure to set objectives may be Bill Wilson, a business owner who recently told us that he wanted:

• To leave his business within three years (although he was ready to leave right away)
• Financial security, defined as a seamless continuation of his current lifestyle
• To transfer the business to his management team

A quick review of Bill’s personal financial statement, however, revealed that most of the income required to maintain his lifestyle would have to come from the business. Unfortunately, his business wasn’t large enough to attract a cash buyer. And, since Bill had done no Exit Planning, his employees had no funds with which to purchase his ownership interest. A long term installment note seemed to be the only answer — a risk Bill was unwilling to take.

Contrast this unpalatable solution with Bill’s objectives — objectives which could have been achieved had he taken the time (well before he wanted to leave the business) to establish and to prioritize his exit objectives.
If, for example, an owner’s need for financial security prevails, selling a business to a third party for cash may be the best and quickest exit path.

If, however, attracting a qualified third party is unlikely or undesirable, an owner may need more time to devise and to implement a transfer to one or more insiders (children or employees) that provides the owner adequate cash.

On the other hand, if an owner’s desire to transfer the business to a specific person or group trumps his or her need for financial security, and his/her deadline for departure draws near, financial security in the form of “up-front” cash must take a backseat.

As you can see, owners must consider—simultaneously—the three primary exit goals (listed below). Ask yourself which is your most important exit objective and rank your answers from 1 (most important) to 3 (least important).

Financial security
1          2          3

Transferring the business to the person of my choice (may include key employees, co-owner or child)
1          2          3

Leaving the business when I want (could be immediately or never)
1          2          3

Prioritizing your objectives will help you choose your overall path and design your Exit Plan. For example, if you want out—soon and with cash—but your business cannot be sold today, do you wait until market conditions improve or sell now to your employees? While prioritizing your objectives is not easy, doing so gives you a framework for decision making.

Start with the choices and priorities in the exercise above, but if you have any difficulty we can ask you some additional questions that will help you make your selections.  When combined with an overview of some critical facts about you and your business, the Exit Planning solutions begin to crystalize.  While we don’t have a ready-made Exit Planning package ready for you, we do have the background and the Exit Planning process that we believe will shine a spotlight on the Exit Planning solutions that are best for you.  We’d like to sit down to talk with you about it sooner rather than later.  Gathering your Exit Planning resources today can help you confirm your path to the future.

Why Exit Planning? Why Now?

“In preparing for battle, I have always found that plans are useless but planning is indispensable.” – Dwight D. Eisenhower (As quoted in Six Crises by Nixon, Richard (1962). “Krushchev. ” Doubleday.)

General Eisenhower’s point was that the process of creating a plan provides value because it forces the planner to consider (and make provision for) “What if events don’t proceed as planned?” A plan not only provides context and the basis for adapting to new and unanticipated events, it also provides alternatives based on assumptions about goals, objectives and resources that may need revision.

As advisors, we know that business owners who create business plans are able to react more quickly to new events than can those without.

Unfortunately, even owners who have business plans fly without Exit Plans, co-pilots, or maps to help them when storms force them to alter course toward their business exits. If an unanticipated event arises (such as a significant change in the national economy), they shelve their Exit Planning thinking (and thinking is all they may have since they haven’t created a written plan) because their only option is to wait for conditions to stabilize or improve. These successful owners would never consider a similar passive response to be acceptable in a business plan.

If the value of an Exit Plan isn’t already obvious, let’s look at a few hard, cold facts.

First, you are far from the only fish in the sea. As the wave of Baby Boomers (born between 1946 and 1964) reaching and passing retirement age crests, the departures of those who own businesses could result in a glut of companies for sale, driving down valuations and giving new leverage to buyers.  Simply put, it may become a “buyer’s market” and sellers, such as yourself, may be forced to accept less-than-ideal prices or terms for the sale of your business.

Second, if you are a Baby Boomer, the generation following you is not nearly as numerous so expect far more sellers than buyers in the marketplace. This too, adds to the glut.

Third, even during boom times not all owners who want to sell their business are actually able to sell.  There is quite a lot of variation, even among similarly sized businesses in the same industry.  Differentiating factors become magnified and elements that were not that important while you were growing your business can become glaring deficiencies.  You need a clear competitive advantage to grow, thrive and ultimately exit on your preferred terms.

Fourth, if you choose to wait for an ideal time to exit as your exit strategy, such as when buyers are active or markets are good, you give up control of the timing of your exit, how much and the terms of payment you’ll receive, and even the type of buyer. Are you confident that the next boom cycle in your industry or in the economy overall will appear when you need it?

And finally, if your reason for putting “Exit Plan” at the bottom of the list is because you believe that until the economy or your business improves to a certain level your time and money are better spent preserving and growing business value, understand that working to create a valuable company is an integral part of any successful Exit Plan. So why not start (or move the ball forward) now?

The benefits of Exit Planning include:

• preparing you, your business and your family for a successful future
• control over the timing and terms of your exit
• customized solutions and action steps tailored to your exit objectives
• laser focus on the value-building aspects of the business that buyers seek and successor owners need
• time-sensitive accountability for each action step necessary to build value and position the business for the next owner
• benchmark changes in business value, management team performance and other critical factors

Concentrating your effort today on growing business value—either as a discrete project or as part of a comprehensive Exit Plan—affects both your ability to sell your company and the price you will be paid. In fact, your value-building plan will be inseparable from your Exit Plan.

Bottom line, the process of planning is what we mean by working on, not just working in, your business. Only the planning process sets up the best opportunity to exit your business on your own terms despite the glut of sellers, dearth of buyers, vagaries of the market and investment world, and the myriad of known and unknown influences on your business.

You can start planning today by working through a narrowly focused set of top priorities, or by attacking all aspects of the future of your ownership as a comprehensive process.  It’s your choice. Starting a planning process that systematically addresses the unique issues that are relevant to you and your company positions you to impact your future.  We’d like to talk with you about your goals and how Exit Planning might impact those goals.

Former Business Owners Express No Regrets About Selling Out

“I can’t play golf every day.”

“My wife wants to see more of me — but not at every breakfast, lunch, and dinner!”

“What do other ex-owners do after they’ve sold out?”

Failing to answer these concerns can create vacillation, reluctance, and ultimately, an unwillingness on the part of many owners to proceed with planning for their business exits.

To examine these concerns, lets analyze a panel of former business owners involved in the owner to former owner transition. All three reported that selling out was the “best thing possible for me and for my family.” That said, each owner approached the sale differently and each has pursued different interests in its aftermath.

Tom Frankl was 62 when he sold his high-tech manufacturing firm. He was prompted to sell first when his accountant introduced Tom to Exit Planning and helped him put in place a successor management team. Complementing this concrete Exit Planning step was Tom’s realization that his emotional connection to the business was loosening. When these objective and subjective events converged, Tom began working with his advisors to orchestrate a sale.

Bill Dirrito, the owner of a clothing and apparel manufacturing company, entered his business with one goal: reach $50 million in sales and sell out. Bill reached that threshold and determined that he’d have to make a huge investment to retain his current market share so he hired a transaction attorney and an investment banker and sold the company.

Unlike Bill, John Six, the 55-year old owner of a low-tech manufacturing company was not focused on an eventual sale. In fact, he didn’t want to sell because he felt he finally “had it going just right.”

When confronted with the idea that the time to sell coincides with the existence of continued upside potential, John started thinking about the hard times he’d been through. If hard times returned, he wondered if the company could survive and knew that losing his “upside” would be the least of his worries. He, too, made the call to his advisors.

Having all arrived at the closing table via different routes, each now-former owner has found a similar satisfaction in the decision to sell and in life after the sale. Tom arranged his sale so that his employees kept their jobs and gained greater career opportunities. This gave and continues to give Tom more peace of mind. While he did not have a detailed plan in place for life after the sale, he quickly found new outlets for his energy. He has become the “Park Superintendent” of his 70-acre property. He’s spending time with his wife and family, has time to travel the world, is considering developing some farmland and has taken an active role in community philanthropy. In Tom’s words, “One of the things I appreciate most in this ‘retired life’ is that it isn’t a ‘retired life’ at all.”

John echoes Tom’s comfort with this decision. “Of course I wondered what I would do [after the sale] because I was in that business for 30 years. But the day I walked out of there I never looked back. I never missed it. It’s incredible but my schedule is calendared 18 months ahead.” On John’s calendar are motor home vacations, developing an industrial park and expanding his world class collection of race cars. John leaves the house by seven each morning and doesn’t find his way home until late afternoon.

Bill, the planner of the group, anticipated that he’d need a place to go— outside of his home — on the day after the sale. He rented and equipped an executive suite and mapped out the first three months after the sale. Today, he spends time on his hobbies (golf, horses and motorcycles). He has educated himself about investing, advises other business owners and works collaboratively with his investment manager.

By any yardstick these former owners remain engaged and vital. They have moved into a new era in their lives — an era untroubled by financial concerns.  Not every former owner has the same experience, but our firm believes that owners who thoughtfully plan their exit increase the likelihood that they will be satisfied with their exit and whatever follows.  We’d like to sit down and talk about the role that we can play in crafting a future that works best for each and every business owner.