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15 Ways to Increase Value


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This is a primer for entrepreneurs on the art of maximizing value in the sale of a business. Rule #1: Run your business as though it will be sold tomorrow. That way, you will always be in the best possible position to take advantage of rapidly changing market circumstances, including extracting the best deal from unsolicited offers to sell.

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15 Ways to Increase Value

  1. 1. 15 Ways to Increase the Value of Your Business A unique, practical guide prepared for you by transaction experts at New York Charlotte Chicago Dallas Omaha Los Angeles Canada China France Germany India UK © 2009 Copyright GroGroup LLC. All rights reserved Page 1
  2. 2. Introduction Welcome to our world, where we focus on maximizing value. Private company value, particularly in transactions that result in the transfer of control (e.g., gifting, inter-generational sale, ownership dis- tribution, recapitalization, outright sale of ownership) is not a single number, nor is it static outcome. Actually, it is a dynamic series of per- ceptions, a state of mind that can be transformed into money in the bank. Assigning value is a complex process that is influenced by myriad, concurrent influences. Positioning, presentation, preparation, compe- tition, techniques and knowledge all contribute to the equation. In the sale of control, the two biggest and most controllable variables of all determine most of the outcome: (i) how the process is handled and (ii) the stage in the business cycle at which the selling dialog matures. These two factors alone will either cost you substantial wealth, or pro- duce incremental value far greater than any other single thing you might attempt to do, setting the stage. Here are fifteen of the most universal key factors that you, the entre- preneur, can manage and implement to impact the value of your busi- ness. Are there others? Sure, but those tend to be specific to an in- dustry, region or temporary market circumstances. If you work these fifteen factors properly, your business will be worth more, when you decide to borrow money, sell, or transfer control in other ways. These 15 Key Factors (also called value drivers) represent the inside story on what generally affects the purchase price of businesses. Based on real-world transactions, these factors come directly from skillful business buyers. Make no mistake about it, in a professionally run selling process, it is those informed and carefully positioned buy- ers (motivated by greed, fear of loss, ego and whatever else) who are the true arbiters of value. Page 2
  3. 3. With a wealth of experience acquired by funding and/or investing $1.25 billion in 68 businesses; buying and selling 130 businesses for about $400 million; starting two businesses; and turning around another for sale to a Fortune 25 company, GroGroup professionals are in a unique position to provide these insights. In the process of representing busi- ness owners, we have interacted with thousands of business buyers, ranging from multi-billion dollar strategic companies to million-dollar in- vestors. This guide was prepared to assist you, the business owner, in planning and directing your efforts so that, when the time comes to benefit from your enormous investment of money, time, emotion and effort, every- thing will be properly positioned to command the best possible value. So, go ahead. Try it out. Make it grow. Call us when you are ready to set things into motion. Until then, take good care of your baby, the marvelous family money tree that you have created and nurtured. PO Box 12356, Charlotte, North Carolina 28220-2356 tel (980) 275-4340 fax (919) 869-1866 Page 3
  4. 4. Key Factor #1 Develop Proprietary Products Selling products that are proprietary (by reason of technology, design, branding, or even packaging) will mean both (i) higher profits along the way, and (ii) be a major plus in the eyes of a buyer. Proprietary prod- ucts protect you from competition and also enable you to elevate your selling/value proposition to something beyond price. Contrast this with commodity products and job shops, where the company does not con- trol the product value; in fact, the marketplace dictates it. Cash flow realities may obligate you to deal in commodity-type products in the near term, but efforts to build equity value should eventually be rewarded if you infuse product/service lines with branding and other proprietary content. Interestingly, this higher-margin model even may reduce incremental working capital needed to support growth. One client company fabricated items from advanced materials, gener- ally in a job shop industry. Yet, through investment in people, equip- ment and R&D, the company developed unique products with excep- tional profit margins. As they accelerated their movement away from commodity products, the value growth actually accelerated because of two things: (i) the level of profitability on each dollar of sales revenue spiraled upward, and (ii) the purchase price multiple achievable jumped, too. Another client took a different, but equally successful approach. A dis- tributor, they didn’t actually make anything, but repackaged (or private- labeled) over 80% of all products they shipped. Even things as basic as simple wood screws carried their logo, trade dress and packaging style. Margins were well over 50% because their products appeared to be unique (proprietary). Page 4
  5. 5. Key Factor #2 Key Factor #2 Serve Niche Markets Serve Niche Markets Trying to be everything to everyone in a major market can blur your Trying to be everything to everyone in a major market can blur your company’s image, exposing you to harsh competition. In good markets, company’s image, exposing you to harsh competition. In good markets, you are better off owning 30% of a niche than 1% of a broader market. you are better off owning 30% of a niche than 1% of a broader market. Niche players have a sharper focus on specific types of customers, Niche players have a sharper focus on specific types of customers, know know them in minute detail, and can, therefore, offer them superior ex- them in minute detail, and can, therefore, offer them superior exper- pertise, service and products. tise, service and products. One client who did this well sold pipe—but not just any old pipe. They One client who did this well sold pipe—but not just any old pipe. They focused on specialty products, such as stainless steel, Teflon and glass focused on specialty products, such as stainless steel, Teflon© and glass pipe for pharmaceutical and other process industries. As a result, they pipe for pharmaceutical and other process industries. As a result, they became the leading distributor in that niche, with sales of $20 million is became the leading distributor in that niche, with sales of $20 million is several regions where their customers knew and respected them. several regions where their customers knew and respected them. This company sold for a premium because buyers valued their domi- We were able to sell this company for a premium because buyers valued nance in this desirable niche market. their dominance in this desirable niche market. Key Factor #3 Sell Consumable Products Key Factor #3 With consumable products, your first sale is only the beginning of a stream of sales. Sell Consumable Productsturnover is re- Reorders can be automatic; customer duced. Buyers of businesses love repeaters, because of the predict- With consumable products, your first sale is only the beginning of a ability of sales. stream of sales. Reorders can be automatic; customer turnover is re- duced. Buyers ofexamples in love experience was a clientthe predictabil- One of the best businesses our repeaters, because of who sold busi- ness forms and tags used by local dry cleaners. Each sale averaged ity of sales. about $300, and business was quite de- One of the besta result, the group that pendable. As examples in our experience was a client who sold busi- ness forms and tags used by local dry cleaners. Each sale averaged purchased this business paid a higher about $300, and business was quite dependable. As a result, the group multiple for it than they had for an that purchased this business paid a higher multiple for it than they had equipment reseller they were purchas- for an equipment reseller they were purchasing concurrently. ing concurrently. Page 5
  6. 6. Key Factor #4 Build an Organization Buyers really don’t like a ‘one-man band.’ A business that depends on only one or two people carries an incredibly high risk in the eyes of a buyer, and therefore is perceived to be of low value. To build a deeper, stronger management team means that you must relinquish some control to others; it also in- creases costs and involves some risk, particu- larly if you’ve hired the wrong people, or not trained them either to make decisions or work independently. The payoff, however, is better operating results, lower stress and a higher sales price. We’ve been fortunate to have had many cli- ents who recognized the importance of build- ing a strong organization. One owner hired a senior executive from a major company, who professionalized the company, developed a marketing strategy and grew both sales and profits. At the time of sale, this strong organization commanded a pre- mium value and also enabled the seller to hand over the keys at clos- ing and retire—the buyer trusted the professional team to handle the transition without the seller’s continued involvement. NOTE: Our experience shows that an owner’s ability to manage a team is greatly enhanced by two closely related things: 1.a bottom-up, participatory budgeting process; and 2.a very responsive financial reporting system that can quickly flag to you (and them) how they are performing, relative to budget (i.e., what they committed that they would do). Page 6
  7. 7. Key Factor #5 Beware of Size, a Double-Edged Sword Larger businesses are often stronger than smaller ones. Among the benefits they can offer are better market share, broader product lines, multiple locations, more assets, deeper management and greater ca- pabilities. Recognizing this, buyers often set minimum sales size as a criterion for screening acquisition candidates. Because the notion of ’critical mass’ is both accepted and comfortable, everything else being equal, big companies pay high multiples for large targets. For example, we represented the owners of two very popular toy companies a few years ago; one had revenues under $10 million, the other was closer to $60 million. Each was a dominant player in its own niche, and both were aggressively pursued by prospective stra- tegic buyers. Each commanded a handsome premium valuation. However, the larger entity’s final value came in at a multiple nearly 40% greater than that awarded the smaller player, in no small meas- ure because the larger entity attracted every major global strategic buyer in the ‘boy toy’ segment of the market. They all bought into in the idea that our client would have an immediate, accretive impact on combined reported results. Size can hurt, however. When the goal is market share, or simply size, profits often suffer. The resulting high working capital demands can lead to strained finances. Also, more debt means increased risk. Larger businesses can be more complex and harder to manage. Is a business that earns 10% pretax on $10 million of revenue worth more or less than a business earning 3.4% on $30 million? It depends on other factors, such as this: if both have the same book value, but the $30 million company is carrying $8 million more in debt, it’s very likely the smaller business will be worth more to a buyer. A prospective client had more than 100 hundred fast food stores. The company was losing money and deeply in debt, but the owner’s response was to grow even faster, and he added another 35 stores. His compulsion to grow put his business in jeopardy, so we coun- seled him to re-think his strategy, rather than sell. Page 7
  8. 8. Key Factor #6 Produce Credible Financial Statements Financial statements provide a record of the financial results of a company’s operations, as well as statements of assets and liabilities and the sources and uses of cash. Many buyers are turned off by fi- nancials they deem to be untrustworthy. Buyers lose faith in the seller’s credibility if the financial reports look ‘different’, or lack clarity and specificity. It should be obvious that unsupported tax returns rarely pass muster. Professional acquirers are accustomed to seeing monthly, quarterly and annual financial statements, usually ‘reviewed’ by an outside ac- countant. The gold standard is to have your financial re- ports audited and certified. Financing sources need such statements to approve a buyer’s loan request, and au- dited financials are a basic requirement for going public, or for being a ‘significant ac- quisition’ for a smaller public company. Because buyers like to see unbroken, sustained trend lines, you should have credible financial statements available for at least three years. In cases where outside accountants have not participated in preparing the financials, we ask our clients to have them reviewed and re-issued. If your traditional accountant isn’t comfortable with this task, we can recommend capable accountants to assist him. Frequently, clients prepare their own financials. We advise them to hire a CPA to review and re-issue the statements, going back 3-to-5 years. By taking this simple preparatory step, we are then able to approach professional buyers; often achieving better deals for our sellers. Page 8
  9. 9. Key Factor #7 Develop a Broad Customer Base Perceived risks play a major factor in every buyer’s internal purchase price deliberations. A business with many independent customers is generally believed to be more predictable and represents a lower risk than a similar business that depends heavily on a handful of major customers. An acquirer will be very concerned if a uniquely personal or familial relationship exists between the sellers and a key customer. Many good businesses are unsalable at reasonable valuations for just this reason— one or two customers dominate the seller’s reve- nues. Whether the owner is wiling to admit it, his business actually functions as subcontractor to those key customers. While it is easy to fall into the trap of customer concentration, the value and deal structure consequences can be severe, because buy- ers are always concerned that the key customer could take those large orders elsewhere. Note: The same issue may exist in the way you source raw materials, components, and other supplies. Specifically, if you are dependent upon a single vendor for a critical item, it would be wise to develop alternative sources of supply. Page 9
  10. 10. Key Factor #8 Formulate and Follow a Strategy A good business with a clearly-articulated strategy usually com- mands a premium. One client did an extraordinary job in the printing industry by target- ing only one type of customer and one product. They focused on short runs, quick turn-around, and bought specialized used equip- ment that they re-engineered to accommodate rapid changeover of jobs. By carefully refusing to make any other printed products, the company became so proficient in its specialty niche that the selling price of the business far exceeded expectations. In contrast to the high price com- manded by the printing company with its clearly defined business strategy, we often see businesses selling at a discount because they are actually agglomerations of unrelated busi- nesses. One client was in several markets and even had two joint ven- tures interwoven into the business, severely limiting the universe of pos- sible buyers. The more different ‘businesses’ a company is in, the more difficult it becomes to find a single buyer who will pay the best price for each and every one. Page 10
  11. 11. Key Factor #9 Steadily Increase Sales and Profits Buyers make many judgments when reviewing prospective acquisi- tions, including how much they can expect to earn from each specific investment. Forecasts are key to this exercise, but forecasting the outlook of a company replete with ups and downs in sales and profit is difficult, so buyers tend to dismiss these deals, or value them far lower than those with more reliable-looking histories. When we first evaluate whether or not to accept a seller as a new cli- ent, we naturally emphasize steady trend lines—absent those, there must be a very solid story behind the choppy history. In one instance, the prospective seller’s revenues and profit dollars fluctuated greatly because they were in a commodity-driven business. So, looking for other attributes, we noticed that the operating profit margin (operating profits divided by net sales) remained constant, with even a slight upward tilt over time. That told us that they were proc- essing orders skillfully and managing the business well; and that at- tribute became our featured selling ‘tag line’ in presentations to buy- ers. Why? Our experience demonstrates that major players often ac- quire others primarily as a means to capture solid management teams and/or well-trained additions to their work force. Targeting specific niches in growth areas of your industry will help cre- ate and protect your sales trend lines, and will tend to attract strategic buyers who pay a premium for quality acquisitions. Page 11
  12. 12. Key Factor #10 Low Debt + High Book Value = Higher Price Debt outstanding at the time of sale usually is retired by the seller out of the proceeds of sale, reducing the net price received. We have seen too many businesses that were impossible to sell for a net price satisfactory to the sellers because the debt they had accumulated ex- ceeded the gross value of the business. How can this happen? Any of a number of things can produce this imbalance, including: a pattern of excessive distributions to owners; high growth consumes too much working capital, thereby outstripping the ordinary cash flow’s ability to sustain the balance sheet; the na- ture of the business requires an unusually high investment in fixed assets; cost of a recent expansion hasn’t been recovered; a recent acquisition was supported by debt that hasn’t yet been prepaid; or, as we see in too many businesses, it is simply under-capitalized. HINT: Higher book value of stockholders equity is a positive in the buyer’s assessment of value and price, and can even provide an illu- sory floor for pricing negotiations. When we sell a business, we re- view the assets to see which have higher market values than stated on the books, and ‘recast’ the balance sheet to reflect these other- wise hidden values. We want our client to receive full benefit of the higher value, not the buyer. Page 12
  13. 13. Key Factor #11 Be a ‘Player’ in a Major Industry To attract the big buyers who pay the big prices, you need to be a ‘big shot’ too. The company with a proprietary product in a tiny or shrink- ing industry sector is unlikely to be in high demand to acquirers who pay higher prices. Why? Because they look for (and expect to real- ize) the benefits of ‘synergy’ commonly thought to be available when overlapping companies are merged. One of our label manufacturers generated a very high level of interest from two major industries: label manufacturing (naturally) and busi- ness forms manufacturing. The latter came about because we no- ticed the client used the same distribution network as the business forms manufacturers. So, using semantic differentiation, we accu- rately made them a part of that larger, rapidly consolidating industry. Once we were in the door, we captured the attention of the big boys. A $600 million public business forms company bought our much smaller client, and at a substantial premium—because of the syner- gies they expected to harvest. Page 13
  14. 14. Key Factor #12 Look Sharp Mom was right—first impressions DO matter. Appearances, no matter how trivial the individual items may seem, all become part of the fabric of the buyer’s initial opinion of the quality of management and, therefore, the value of the business. Mow the grass and plant flowers. Get rid of the clutter in the factory, ware- house and out back. Paint the building, inside and out. Pave the parking lot and re-paint the lines. ...and yes, clean up your office and pitch all of that ‘stuff’ you’ve accu- mulated. Most importantly, address all environmental issues NOW. Hazardous waste record keeping and procedures should be up-to-date and com- plete. Have your attorney engage an environmental engineer do a Phase 1 audit, walk the property, and determine if a Phase 2 is rec- ommended. Fix all deficiencies. Remediate. Waste, unused barrels and all chemicals should be removed or properly stored; otherwise, the buyer will ask questions and/or demand further testing. Environmental issues, whether real or imagined, kill deals. Period. Page 14
  15. 15. Key Factor #13 Use a Merger & Acquisition Professional to Sell Your Business Engaging the services of a good M&A professional will give you a significantly bet- ter chance of selling your business—to a quality buyer, for a better price, on a timely basis, and on better terms. Consider this:  Most business owners will never sell even one business; the best buyers purchase several companies every year. You will be outgunned if you chose to ‘save the fee’ and go it alone, and that will be a painful and very expensive education  It takes 700 to 1,000 hours of preparation and meetings to do a deal. Can you afford to neglect your business for ½ of a year at the very moment when operating results matter most? You should focus your efforts on running the business, and let your M&A professional conduct the extensive analysis, preparation, sales and marketing efforts  The best results are achieved by marketing the deal quietly, but broadly to many qualified buyers. When we market a business, we start with a rigor- ous search for public companies, both here and abroad, because these entities consistently pay the highest prices and offer the most solid deal structures. We also know who, among the thousands of mercurial financial buyers, actually close deals without a lot of fuss  Don’t put a price tag on your business. In any negotiation, the first person to name a number loses. Our highly perfected selling technique is crafted to bring multiple buyers to the table simultaneously. This creates a fear of loss in their minds, causing them to pay more than they might otherwise offer. Our credibil- ity with these quality buyers induces them to participate. It all comes down to another basic rule: One buyer is no buyer. These alternatives give our sellers the comfort to push buyers hard to achieve the best possible deal  A professional, credible presentation of your company’s strengths and opportunities is key to marketing it properly. The buyer is purchasing the future, but will try to pay you for the past. Unrepresented business owners hand over tax returns and old marketing pieces, but none of that speaks to the future. For buyers to pay up, they need to believe in the company, management team, work force, products, competitive positions, barriers to entry, capacity for ex- pansion, market potential and market share, and a host of other variables. Your selling presentation is your ‘silent salesman’—make sure it tells the story properly to all of the unseen decision-makers on the buyer’s side of the table. continued... Page 15
  16. 16. Key Factor #13, continued...  To maximize perceptions of value, hidden earning power and assets should be properly understood. Your financial statements should be recast to re- flect these attributes, and the recasting should be credible  If you want to be paid for a bright future, credible projections need to be developed. They should be based on well-articulated supporting evidence, including relevant market research and data  Unqualified buyers are time-wasters, should be identified in advance and excluded from the process. Our thousands of buyer contacts prepare us to screen out these pests quickly. Becoming involved in the dealing ‘dance’ with an unqualified buyer is a waste of time and money; it may drive away legitimate buyers; and it could actually cost you the opportunity to sell your business  Hiring a professional who has completed many visible and noteworthy sale transactions establishes the seller’s credibility, not only with regard to seri- ous intent to sell, but also in the information given to buyers  Be aware that the complex terms of sale are every bit as important as the agreed purchase price. You should have the advice of someone famil- iar with the many financial aspects of selling a business. Reps and warran- tees, subordination, earn outs, royalties, holdbacks, escrows and employment agreements are but a few of the items that can be part of your deal.  Your M&A professional will be the quarterback of your deal team, so chose him carefully. Other members of this deal team include an industry expert (you), a legal expert (probably special M&A counsel hired by your tra- ditional attorney to handle the highly complex nature of M&A documents and risks), a tax expert (either your accountant, or lawyer, or special counsel), and a wealth strategist. The bottom line is this—you’ll probably only sell your company once. It is likely to be the greatest part of your fortune and personal legacy. Huge portions of po- tential value are made or lost in this carefully choreographed contest of skills. A true professional will improve your deal by many times the fee you will pay him to handle this process. We do. Page 16
  17. 17. Key Factor #14 Think Taxes There are many tax-minimizing things that you can do now, in prepara- tion for the eventual sale/transfer. For example, if you are taxed as a C Corp, consider an S Corp election. That simple step could eliminate double taxation on earnings as well as on distributions of sale pro- ceeds. Real estate should be held away from the company for a few reasons, including that it allows you to accumulate wealth in a ‘safe haven’ away from the risks inherent in the business model. It also facilitates gifting and estate planning. Many buyers prefer not to purchase real estate; rather, they lease it for a period of time, with options to extend or pur- chase at a future date at prevailing market values. Were the property held inside the business, these actions create a burdensome double- tax for you. Also, real estate is best sold separately to a real estate fo- cused entity, usually on better terms than corporate buyers pay. If intellectual property is key to the business, it too is best held sepa- rately by the owner—isolating it from the risks of the business (and al- lowing the owner to receive royalties as another way to remove cash flow from the company). Upon sale, the buyer would acquire this IP concurrently, circumstances permitting. Then, a substantial portion of the total purchase price could be allocated to the IP, producing signifi- cant tax benefits to the buyer. These quickly sketched ideas are intended to provoke a far-reaching discussion among you and your professional tax advisor—naturally, you should act only after they have advised you of likely outcomes and other particulars. Also, keep in mind that each situation is different, as are the complex, ever-shifting state tax rules. The important thing is that you speak to your advisors NOW about that day in the future when you might possibly decide to transfer or sell control. Ask them what they can do to TODAY to maximize your tax advantages. This is important. Page 17
  18. 18. Key Factor #15 Time the Sale Correctly The best time to sell is when the market is ready. However, if you have been running your business to maximize value, then you will be ready, too. Consider this: We’ve been working with and talking to owners of a large IT consultancy since 2005. When we first met, they were recov- ering steadily from the recession that followed the tragedy of Sept. 11. By early 2008, things were perking along very nicely: sales were up, profits were up, and the business was poised to grow another 15%. His wife (no longer active in the business, but still a 50% owner and anxious to relax, travel and enjoy their grandchildren) said “Let’s sell now.” The founder, now 63 and getting ready to pack it in, uttered those famous last words, “One more good year, and then I’ll sell.” Sound familiar? ARG! The business grew as predicted and now he wants to sell, but the mar- ket is down 60%. Instead of adding 10%+ to the sale value, he actu- ally LOST ONE HALF of his perceived worth. When will he be able to reach his goal and retire now? 2012? 2013? Later? Can you avoid that all-too-familiar trap? Sure. Run your business with the first 14 Key Factors in mind and then you will be ready to take ad- vantage of market peaks when they occur every 5 or 10 years. Also, if you are doing a particularly astute job implementing some/all of Keys 1, 2, 7, 11 or 12, you will attract the attention of strategic buyers, no matter what the market conditions. Throughout the first half of the 20th Century, a fin- ancier named Bernard Baruch was one of the wealthiest and influential men in America. A reporter from the NY Times once asked the se- cret of his success. Without hesitation he said, “I always sold too soon.” Page 18
  19. 19. We and our affiliates are an international merger and acquisition team that specializes in: Sale of businesses—we represent sellers on an exclusive basis. Our comprehensive service includes:  Preparation of the seller’s tool kit, consisting of a comprehensive selling presentation, teaser profile, marketing blurbs and other mate- rials, as circumstances indicate  Using our comprehensive proprietary buyer contacts, knowledge and myriad databases, we identify strategic, synergistic and finan- cial buyers, both at home and abroad  Contact buyers, arrange visits, frame the dealings, and coordinate the activities of the professional deal team to maximize and close the deal our client selects Acquisition of businesses—using our acclaimed SYSTEMatic© Ac- quisition Search protocols, we conduct retained global searches for strategic serial acquirers. Our specialty is finding businesses that are not for sale, then opening doors and setting the stage for a cordial, pro- fessional, deal-producing dialog. Building business value—working with business owners as a sound- ing board and resource tool kit, we identify areas for improvement as well as timely strategies for rapid progress. PO Box 12356, Charlotte, North Carolina 28220-2356 tel/ +(980) 275-4340 fax/ +(919) 869-1866 © 2009 Copyright GroGroup LLC. All rights reserved Page 19