Reflections

Understanding how a future acquirer will value your business is key to a euphoric exit outcome

There are multiple ways of valuing a business but for most acquirer’s, it’s the future value of the cash flows of your business that will be the starting point for how much they are willing to pay you for your company. The misconception by many private company owners is if they have good revenue and good profit then an acquirer will pay them a premium at time of acquisition. Although having historical and projected strong revenues and profits is a great ante into the game of selling your business, it’s not the only thing that will determine whether the acquirer will be willing to pay you a premium.

Every industry is unique so ensure you understand how a future acquirer within your industry is going to place a value on your business. This isn’t something you want to wait to find out only to learn you missed key value, or net worth, drivers in the eyes of an acquirer. Begin thinking and planning today for what the future of your company cash flows will mean for your exit event. Let time be your friend in this regard as you can take steps today to improve your future cash flows and increase the likelihood of one day achieving a euphoric exit event with your company.

Knowing where you play can be key to a future successful company sale

Every industry has an ecosystem, do you know what yours is and where your company is positioned within it?

James Moore originated this strategic planning concept of a business ecosystem in the early 1990’s and initially it was intended for the high tech industry. But today, every business in every industry has an ecosystem. A business ecosystem is comprised of the network of suppliers, distributors, customers, competitors, etc that are involved in the delivery of a product or service. The idea is each entity within the ecosystem affects and is affected by the others and this ecosystem becomes a constantly evolving network.

The reason it’s important to identify where in your industry ecosystem you play is in each ecosystem there are those entities which are considered high value, essential players and others that are of lower value, less essential and could be more easily replaced. Building your company to be a high value, essential entity with your industry ecosystem could mean the difference of millions of dollars to you as the owner/CEO at time of company sale to a third party.

As a very broad example, there is an ecosystem within the technology industry where there are entities within it that focus on hardware and others on software. Early on in this ecosystem, the hardware players were considered high value entities but over time, it’s the software companies that have taken over as the higher value entities and in many cases relegating the hardware providers to more of commodity status. All the players in an ecosystem play a role otherwise they’d be knocked out. But the key is knowing whether the role of your company is playing a high value or lower value role.

When the day comes that you look to attract a third party to acquire your company, you will want to be able to articulate where within your industry ecosystem your company participates and that you’ve built a business that is in what is considered to be a higher value area of the ecosystem. Doing so could be a major difference in determining whether you are euphoric with the payout you receive for your company. We help clients determine this for their business and help them drive up valuation, talk with us (949.874.0787) to help get you started in answering this question for your company.

Achieving your future euphoric exit event starts today

Ask yourself this question – do I know what the future tax bite will be when I sell my company? If the answer is no, now is the time to meet with a seasoned business tax advisor to discuss this.

A common complaint heard from company owners, that have sold their business, is they reached the day of the transaction event only to find out the taxes due had a far greater impact on the gross to net payout amount than they had anticipated. They express that they would like to be able to turn back time for the purpose of developing a better tax efficiency strategy.

Learn from this mistake that too many have made. As part of your exit preparations, which we help owners do at least 1 year prior to selling their company, include discussion with a tax advisor to see what tax efficient strategies they might help you get in to place. The less time you give them for doing this, the fewer the options they can offer you.

Don’t let the tax man be the reason you aren’t euphoric one day with the sale of your company.

Having the right blend is key to a future euphoric exit event

As company owners and CEO’s we certainly have great passion for our business, which of course is important for leading our team and building long term company worth. When the day comes to sell our company, we have to know that the acquirer will come in initially with a dispassionate view of our business and it’s our job as the seller to move them to becoming passionate.

Initially however, when the acquirer first arrives on your doorstep to evaluate whether they’d be interested in buying your company, their view of your business will be very different than yours. Their view will very often be one of a dispassionate, show me why your company could be of value to them, type attitude. This very often leads to you as a seller having the belief that your business is worth much more than the acquirer believes.  It’s key therefore as we run our business, years ahead of an exit, that we leverage our passion but also ensure we build a business looking through the lens of a future acquirer. Here are some key, dispassionate questions an acquirer will have one day for you:

• What is the financial performance of your business recently and the past 3 years and is it consistently positive year over year or is the performance inconsistent?
• How strong are the prospects for future growth/profitability if under their ownership? Are you proving to them that you have solid line of sight to continued growth?
• What types of risks will there be for the acquirer if they own your business? Are you presenting a business to them with multiple areas of risk to them or have you prepared a business that they will see possesses low risk to them? High risk in the eyes of an acquirer often translates to lower valuation.
• How predictable are the revenues and profits of your business? Transaction based businesses often times garner lower valuations than those with highly predictable ones.
• How easy or complex will it be for the acquirer to assimilate your business? If they want to keep your company as a standalone business, is your team strong enough to stand on its own and continue growth? Or if the acquirer wants to blend your company in to theirs, will they see a clear and low risk pathway to doing so?

Don’t let your personal passion blind your view of your business. As you run and build your company, do so regularly looking at it through the lens of yourself and a future acquirer. Doing so could help you build great worth in your company and enable you being euphoric one day in attracting a third party to acquire it with a great valuation.

Want to sell your business one day, start by asking these questions about your company

As we look to close out the year, business owners and CEOs should be in the midst of planning their strategies, supporting initiatives and budgets for the new year ahead. A high value exercise this time of year is to ask yourself, “what strategic questions do I have about my business?.” Download here the strategic questions we believe company owners and CEOs should be able to answer on their path to building company worth and toward being euphoric one day with their exit event.

Preparing your organization culture is key to preparing for a future euphoric exit event

As private business owners and CEOs we know our market, customers and products and services but how well do we know our organization culture. Too often executives miss the connection between a great culture and great company performance. Read here our latest article on organization culture and steps you can take to ensure it’s enabling value creation in your company.

Most exit options for company owners lead to the same path

It’s not uncommon to hear a private business owner say that selling one day to a third party isn’t an option of interest so preparing for such an event isn’t on their radar screen. For these owners, their thoughts are to transition their company to a family member or perhaps transition it to a member of the management team. These are certainly both very viable options.

Here is what you should keep in mind….either of these scenarios still have one thing in common. And that is at time of your transitioning to a family member or to your management team, a valuation will need to be placed on the business. Just as if you were selling to a third party, transitioning ownership to family or not, most likely you’ll need a valuation placed on the business for various reasons including handling of your personal taxes.

So start thinking today about how to maximize the future value, or worth, of your business because most exit scenarios that you may want to consider will require placing a formal valuation on the business. Optimizing this can take years of solid planning and execution so begin your journey today to plan for your future euphoric exit event.

Should I consider selling my business even during a recession?

Most would think the answer is no because either the recession is negatively impacting your company performance and/or acquirer’s aren’t looking to conduct acquisitions to reserve their cash through what could be a difficult time for them. And if they are acquiring, they are looking to do so on the cheap which of course won’t serve your best interests.

However, each company is a case study of one and your situation might allow for it to make sense to explore an exit even during a recession. If your company is a solid performing business, has unique competitive advantages, has an exciting future growth trajectory and you’re prepared to successfully withstand a third party due diligence, then businesses like this can sell at any time and even command a premium valuation. But if your business is struggling or performs inconsistently in recent years and doesn’t offer a truly unique business to an acquirer, then most likely a recession is not a time to consider exiting.

Our advice to clients is to build a business that could always attract an acquirer in the event that either you wake up one morning and decide it’s time to exit or you are approached by what you deem to be a very strong partner for your business and want to take advantage of their being in an acquiring mood. So for some businesses, they will be able to command a premium valuation from attractive acquirers even during a recession but others may not. If you’re considering trying to exit in the next 12 months, speak with an investment banker or give us a call and we can outline specific questions and steps you could take immediately to help you answer this question specific to your company.

Future acquirer's will factor this into the valuation they place on your company

You’ve built and continue to lead a successful company that could allow you the potential one day of selling to a third party. When that day arrives, will an acquirer view you personally as being essential to the ongoing success of the business or will they see that you’ve built a team around you, allowing you to step away at time of sale? The answer to this question will have significant implications on how much the acquirer is willing to pay, even if they will be willing to pursue the acquisition at all.

Ask yourself these questions –

• Am I able to take at least a two-week vacation and not need to have frequent communications with my team back at the office?
• Do I have key managers in place across my company that I have confidence in the decisions they make on their own when I’m out of the office?
• Have I prepared and empowered key managers to make important decisions for my business in my absence?
• Are my key managers clear on what level of decision making authority they have in my absence?
• If customer issues arise when I’m out of the office, is my team capable of managing them effectively without me?
• Are top customers and suppliers willing and confident to work with key managers on my team in my absence or do they only want to deal with me?
• Are the innovations that occur in my company, such as launching new products or services or making meaningful improvements, all driven by key managers on my team and if I leave the company one day, these innovations will continue?

If you answered “yes” to all of these questions, then you have the potential for showing a future acquirer one day that your business can continue on successfully without your leadership. If you answered “no” to any of these questions, it’s important to get to the root cause. Being able to show that you’ve built a team that can operate the business successfully in your absence will be key to building the valuation of your company in the eyes of a potential acquirer. As we frequently comment, you want to be euphoric one day when you sell to a third party and your role within your company will be a critical factor of success in achieving such a desired outcome.

Rethinking how your company provides customer discounts can have positive financial impact

Ask yourself this question related to your customer pricing – “when is the last time we reviewed the effectiveness of our pricing and specifically as it pertains to pricing discounts we offer?”

The fastest path to growing your profit margin is through price increases. Now most people would say that raising prices is very difficult and quickly move on from further thought on the topic because it is so hard. But rather than thinking about raising prices, give thought to reducing the degree of discounts.

For many businesses, the typical scenario is we provide our customers a price for our product or service and often times they come back asking us for “more”, or a discount. In return, very often our sales team is programmed to reply with a discount offer of 5% or 10% and hope this pushes the customer to purchase from us. But why is it that we think in terms of 5% or 10% type increments, why not 2%, 2.5% or 3% or 7%? Many times, the customer is asking for better pricing simply because there is no downside to doing so and when you reply with 5% or 10% they then act because you check a box for them. But will they say no if you offer an additional 2.5% discount versus the 5% or will they accept this to check a box, tell their boss that they didn’t accept your initial offer and got a better price from you. But instead of you giving away 5% profit, you gave away half of what you traditionally would do. They win by getting the better price they needed and you win by keeping more of the margin in your pocket.

At time of a future sale of your company, the acquirer will want to understand your price strategy and how it impacts the gross margin of your products and services. They will look to see if your gross margins have increased or decreased over the past few years and when they see you increasing your margins, this builds company value in their mind and may get them to pay a higher price for your company. Periodically revisit your pricing strategy and specifically your discounting strategy.  As a boss early in my career told me at Black & Decker, “don’t be predictable with your pricing as over the long term it will make it easier for to competitors to compete against you”.

Know where your culture is being driven from

Ask yourself this question – is there a functional department within my company that sets the tone for my overall company culture? If your answer to this question is yes, the natural follow-on question is do I like the cultural tone that department is setting for my company?

When the day comes that you want to present your company to a potential acquirer, they will assess what they believe your company culture is as they place a valuation on your business. For this reason, years in advance of attempting to sell your company, you want to ensure you’re driving the right culture.

Over the years of running various businesses, it was clear to me multiple times that there was a lead department in terms of driving the cultural tone of the company. Whether it be a negative or positive culture, I found a particular department was primary in setting the tone. It was my job to determine what the company culture was and if it wasn’t enabling to building our company enterprise value, my job was to identify what the root cause of the culture problem was. Most often I found the root was a particular department and addressing that area of the business put the company on a much better footing for driving progress. And the reverse can be true, a positive culture that as the leader of the business I wanted to ensure I was protecting and nurturing.

Your goal is to have an enabling culture across all of your company department’s and you can’t afford to have some departments supporting your desired culture and others that are not. If you’re not pleased with your company culture, think about it at the department level. In the majority of cases, if you’re not pleased you will find that it is emanating from a particular area of your business. It’s our job as owners and CEOs is to protect and build our company culture and the reward will be leading a team that creates enterprise value that will reward you when the day comes you want to attract an acquirer.

Make sure key terms of your customer and vendor contracts protect and build enterprise value

Through the course of doing business, your company negotiates and agrees to various contracts with customer and suppliers. There are several terms contained within these agreements that could one day be viewed as enterprise value enablers or disablers in the eyes of a potential acquirer. Here is our list of key terms that you will want to pay extra special attention to and ensure the contract will be viewed positively when the day comes you may want to exit to a third party. (See List Here)

Our goal in working with clients is to make them euphoric with their exit outcomes and negotiating customer and supplier contracts is a key element in this journey.

Practical tips for improving your company hiring effectiveness

Most business owners and CEOs would agree that their employees are a critical factor in helping their business succeed. Underpinning this is the ability to hire and retain the right people. Let’s focus this week on the “hire” phase and specifically the art of interviewing.

Many managers never receive formal training on how to conduct an effective interview. This is a big missed opportunity for owners and CEOs in building the value, or net worth, of their company given the time our managers may spend each year interviewing for new employees and making hiring decisions. Here are practical tips to discuss with your team on how to enhance the interviewing process at your company:

• Start with “deliverables” in mind. Too often hiring managers start by drafting a job description that usually includes a very broad overview of the role they are hiring for. Writing the job description should be the second step. The first is identifying what this employee will be responsible for doing in terms of “deliverable(s)” for the business. Identify how the hiring manager will define what good looks like in terms of this new hires job performance (deliverables) at the end of their first 3 months, 6 months and first full year. Giving quality thought to what deliverables you will need from this new hire will greatly increase the liklihood of your finding and onboarding the right person.
• With the deliverable(s) now in mind, craft the job description that will outline more accurately what the role is that will be able to achieve your desired deliverable(s). Instead of putting in the kitchen sink of responsibilities, experience and characteristics in the job description, knowing the deliverables you’re looking for will help you craft a more focused position description.
• With the job description written, the third step is crafting effective interview questions by looking at the deliverable(s) you’ve set for this position and identify questions that will help you directly see if the candidate possesses the experience and characteristics you know will be needed. Certainly, there are standard questions you can ask in most any interview for any job type, but you also want to add custom questions specific to the role you are hiring for. If you only stick to your standard stable of questions, you may miss interviewing the candidate for specifically what will be needed to help them achieve the deliverable(s) you need in a particular role.

Talk with your team about how effective your company is at hiring and of course retaining employees. But too often managers talk more about the retention aspect and miss the power of the initial step, the interviewing and hiring. Discuss where your team could improve in the interviewing process and in doing this you could be taking a powerful step forward in strengthening your hiring of the right talent that can then help you build the future net worth of your company.

 Leverage our template to facilitate productivity dialog with your team

During these times of challenging supply chain and labor issues, business owners and CEOs have to find ways to do more with less. In addition, every owner and CEO should constantly monitor gross margins of the business and look for continuous improvement opportunities to drive them up. A key question to ask yourself is what steps could my team take to increase the productivity within our company to drive up our gross margin?

Every business is filled with processes that require the application of labor. We have processes for selling our products or services and we have processes for how we deliver on those products or services. Any steps we can take to increase the efficiency and productivity of these processes could have positive impact on our company margin and ultimately the bottom line.

Having a discussion about productivity with your team starts by asking the right questions. We offer here a template to help you facilitate such a dialog with your team (Productivity template) Ask new questions about the productivity of your processes and potentially identify improvements that could help build your company bottom line and go directly to supporting you one day in commanding a higher exit valuation when the day comes you want to sell your company.

Be prepared to present full ownership of your intellectual property

Ask yourself this question, when selling my business, will I be able to show an acquirer that my company has full control and ownership rights over the intellectual property we have developed over the years? Here are things you will want to ensure you are ready to show to an acquirer:

• Documented proof of ownership of each of your company internet domains, trademarks and tradenames
• Documented proof that third parties you’ve hired over the years to help you create any of your company intellectual property have assigned 100% ownership to your company and that they can’t lay claim to any of it
• Documented proof that your employees, such as engineers, cannot lay claim to partial or full ownership of intellectual property they created while under your employment.
• Documented proof that if your intellectual property includes open-source software from third parties, that you have licensed rights to use their product within yours.

Bottom line here is when you go to exit, the acquirer of your company wants to assess risk. Part of their risk assessment is ensuring that intellectual property they are gaining and valuing within your business is truly yours and that no third party can lay claim to any of it or claim that you are using their product improperly. Exit planning takes time to ensure you can smoothly go through a third-party due diligence. Contact us so we can share tools with you that will ensure you are ready one day for a smooth due diligence process.

Ask yourself these readiness questions to help answer the question

A common question from private business owners is "am I ready to sell my company". The word "ready" means being prepared mentally, the business itself being ready to be presented to third parties and the market conditions to be able to receive your desired valuation from an acquirer. Click here to download a helpful, brief scoring survey that will faciliate your thinking in this critical area. These questions will help you give thought to your readiness and give you an idea of when the timing might be right for you to achieve your euphoric exit event.

And for those wanting a more comprehensive review of their company readiness to sell to a third party, visit our Yosemite Business Diagnostics and let our Greenpoint assessment tool help faciliate you through a series of insightful questions and get results that will help you see where you may be ready and where you may have work to do. And as always, call or email us with any questions and we're happy to offer guidance that can help take away your exit planning uncertainty.

Earnouts are a way for the acquirer to manage risk

What is an earnout in an acquisition? This is a type of deal structure whereby the acquirer will place an overall valuation on the seller’s company and then determine how much will be paid in cash at time of transaction and how much will have to be “earned” by the seller over time through future performance of the business. Earnouts are very simple in concept, but are most often quite complex to negotiate, challenging and stressful to execute.

When placing a valuation on a business, an acquirer assesses the future benefit to them in owning the target company and equally they consider the risk in owning the company. Simply put, the greater the risk the acquirer sees, the more likely they are to require the seller to carry some or all of the perceived risk going forward and therefore accept less cash at transaction closing and move a small or large portion of the overall payout to the future achievement of performance targets.

Earnouts are of the greatest value to the acquirers as they place much of the future business performance risk on the seller. Therefore, as a seller you want to years in advance of attempting to sell, look for ways to reduce the risk that an acquirer might see in your business. Reduce the risk in areas such as too much customer concentration in your revenue and profit, single point of failures in your supply chain, risks within your organization and team and even risks associated with the language in customer or vendor contracts that you’ve signed. With the right prior planning, you can eliminate or reduce the need for an acquirer to require an earnout because they too often don’t like them as they know they are difficult to negotiate, difficult to administer and are often contentious during the periods of time the earnout is in effect.

Start your optimal exit event preparations today by asking where a future acquirer might see risk in your business. Prioritize these areas of potential risk to take steps to either eliminate or reduce each area. Taking these steps today could help you build overall company worth and help you get an acquisition deal structure that affords all the payout at time of close, not having to earn your reward while working for the acquirer of your company going forward.

Things to avoid when the times comes to exit

Talk with anyone directly involved with buying and selling small to mid-sized privately held businesses and you will hear real life situations where sellers had second thoughts about selling their company in the final weeks of the event happening. When this occurs, it adds stress and expense to the deal and can take what was supposed to be a wonderful, potentially life changing event, and turn it in to a nightmare…a nightmare that can be fully avoided with proper planning.

Here are some real-world situations that have given business owners second thoughts - ask yourself, could any of these happen to me?

• Just weeks before the transaction was to close, the reality set in for the seller that they had nothing to do starting the following week of the deal closing. Forty years of going to their business and suddenly no schedule, no meetings or trips on the calendar and stress set in. The seller was so mentally invested in the business that they didn’t think through their life post deal closing. The deal collapsed as the seller changed their mind about wanting to exit and led to a lawsuit by the acquirer to reclaim the expenses they incurred pursuing the transaction.
• A seller who realized too late that something as simple as how they would introduce themselves to new people they met in the future was now creating mental uncertainty. For years they introduced themselves with great pride as the owner of XYZ company as they met people at industry or social events and upon selling their business, were suddenly worried about how they would present themselves. This situation didn’t kill the deal but it did delay it and caused entirely unnecessary stress for all parties involved.
• The seller that certainly knew personal cash flow would be important but hadn’t really planned for this, including how they would be paying for healthcare coverage post transaction. So as the transaction closing date approached, the urgency of thinking and planning for this accelerated and although it didn’t kill the deal, it added an unnecessary layer of anxiety and stress for the seller and her family as they scrambled to figure things out.

Talk with any business broker or investment banker and they can share many stories like this. What they all have in common is that with proper exit preparation, you can avoid them. And know that although your lawyer and CPA will play a critical role in your business sale process, they are NOT the ones that will help you take a holistic exit preparation approach inclusive of the mental preparations.  Get holistic exit preparation guidance from those that have been down this path and can help you get your business and yourself mentally prepared for the event.

Ensure you have a minimum of 3 years of consistent financial reporting

A common mistake that privately held businesses make is they periodically make changes to their financial statements without giving thought as to what the change might mean when comparing financials to prior periods. The problem with this is when a potential acquirer comes in to do their due diligence, they (and you) will find it frustrating and time consuming to compare prior years given the inconsistencies that have occurred.

These inconsistencies might be in areas such as changing how you calculate your product or service gross margin, changes to your chart of accounts and where you report various expense items, what investments you capitalize and changes to your revenue recognition or inventory management policies. Changing any of these at the time may make sense but think about what it will mean to prior period comparisons, especially for the prior 3 years. What seems like a simple change may in fact lead to confusion and stress when you present your company to an acquirer.

Talk with your accounting partner (whether on staff or external) and discuss the year over year consistency in your financial reporting. If you need to make changes, try to make them backward compatible for consistency of reporting sake so that you have a minimum of 3 years consistent reporting of your numbers.  This basic step can help you and your acquirer eliminate unnecessary stress and time delays during due diligence and reduce the likelihood that they may try to lower their initial valuation and deal structure of their offer based on a degree of risk they are seeing in your financial reporting.

Don't assume rewarding your team means giving equity away

A common topic that we work through with our clients is how they might reward their key executives when company sale day arrives. They often assume they have to consider the complexity of providing these executives equity in the business and although this is a viable option, it’s not the only one.

At a very high level, here are the options you have for rewarding key members of your team should you desire doing so when you sell your business one day:

• Subjective award at time of exit – this option has you deciding upon exit what dollar amount you may wish to award key members of your team. You have the right as the owner of the business to subjectively award anyone you wish with a payout from the proceeds you will receive from the acquirer. The upside to this option is it’s purely subjective and is determined at time of exit. The downside is this option doesn’t give you an optimal vehicle for retaining and motivating these key people in the years prior as you prepare for a sale because they aren’t aware of your plans to make such a subjective award.
• Subjective award communicated prior to exit – this option simply takes the option above but has you conveying your plans to your key team members years in advance of selling so as to help excite and retain them in their roles. You convey to these team members of your plans to one day reward them at time of an exit but you remain vague as to how much. If your team members highly respect and trust you then they may be motivated by your subjective plans but in most cases, this option might not have the motivational impact as the team members might be skeptical due to the lack of clarity of your future subjective plans.
• Objective award communicated in a letter – this option has you providing select team members a basic letter, not legal in nature, but one that documents your thoughts to reward them at time of future exit. This letter would identify your plans to one day reward them with either a percentage of the deal proceeds you will be receiving or just a fixed lump sum. This letter doesn’t require lawyers to draw up and informally conveys your plans. This can work if your team greatly respects and trusts you to hold true to the non-binding letter you’ve provided.
• Objective award through a phantom equity plan – this option has you working with a lawyer to draw up a plan that imitates actual equity in your business but doesn’t require giving up actual legal ownership shares in your business. A plan of this type assigns phantom shares of stock, documents very clearly how the plan works for you and the participants and is a legally binding agreement that you would give to your key team members years in advance of your exit.
• Equity participation – this is the most extreme and complex option as it does have you issuing equity in your company to the team members. This option has the same motivation drivers as the phantom plan and shows the ultimate degree of commitment from you to your team but also comes with a greater degree of complexity and cost to set up.

There is no best answer as each company situation is unique in terms of how best to motivate, retain and reward the key members of your team and your personal relationship with them. Get guidance from exit planning advisors as firms like ours can help you determine what will be optimal for helping you achieve your future euphoric exit event. In addition, the option you select may have positive tax implications for you as the seller so making the right decision will not only motivate your key executives but can also provide you tax benefit at time of the exit.