What Can Increase or Decrease the Value of Your Business?
If you are selling your business, proving profitability is likely one of your main priorities. In the world of business transactions, being in the black is not the only thing buyers will be looking for. In many cases, making your business worth the asking price is about leveraging those other factors.
Mike Hirschberg of Northborne Partners joined The Transaction Abstract for a discussion of those enhancers and detractors in a business transaction. As Director, he has helped sellers, buyers, and investors navigate the nuances and pitfalls of the world of M&A. Here is what he had to share about how to position a business for sale.
Enhancers of Business Value in a Transaction
A Strong, Smart, Involved Management Team
"It's hard to emphasize enough how much value a deep, strong, and competent management team can add to potential offers," Mike says. The more familiar, invested, and knowledgeable your management team is, the more value it can add in the sale of a business. And management who wants to stay on can add even more – by "a multiple or two of EBITDA."
"You may have a transaction where a strategic or you assume a strategic acquirer may not want those individuals for the long term," Mike adds, "but being able to present them as an option always drives value and interests, particularly if they're talented individuals ... The important thing is that those individuals are aligned economically with the goals of the transaction and more importantly, that they are aligned or interested in staying involved with the business post transaction."
A strong management team can take years, not months, to create. But the benefits go far beyond what you can get for the business in a sale. Read our blog on The 4 Business Moves You Can't Make Without a Strong Leadership Team.
A History of Growth and a Position to Continue Growing
Growth opportunities can be an incredible enhancer of a business's transaction value, especially if the buyer's goals include acquisition. "Growth opportunities are often a value enhancer to the extent that they are ... able to be articulated to potential buyers or investors," Mike says. Of course, a track record is helpful, but context is key for buyers.
"If you've already acquired a couple of businesses in the past and have a proven ability to integrate those, not just from a pure financial standpoint, but also from a culture standpoint, then I think oftentimes you'll get some credit for that ... but you have to have some discrete numbers around it, and you have to be able to prove out the math to potential buyers."
Using Data to Understand and Run the Business
In proving (and enhancing) the sale value of your business, the quantifiable is always more valuable than the qualifiable. Mike says that even in the world of M&A, "People are focused on using data to … make better decisions."
Key metrics can be used to not just measure but actually drive sales, increase profitability margin, and fill the pipeline – all things that are important to buyers. The data is what makes your business understandable and attractive to potential buyers. Mike says that having a management team who understands the data is vital: "Investors or buyers really want to feel comfortable that the individuals that are ... in charge of the overall business understand what the underlying components are.
"The bigger issue is when you have management that doesn't understand the drivers of financial performance and how individual elements of their decision making affect the broader P&L," he adds. "And when you're meeting in front of investors and buyers and are unable to articulate why certain financial metrics look this way or that way, then that's usually what causes the most concern and then detracts from value."
A Quality of Earnings Report
While a host of different factors can influence valuation and negotiation, there is some truth to the adage that businesses are only as good as their financials and management. To that end, a quality of earnings report has a special importance in a transaction, and not just for the buyer.
"The challenge is always [that] it's a balancing act," Mike says. As a seller, he says, "You don't want to leave money on the table – but if you're too aggressive or you have too many adjustments as a percentage or proportion of adjusted EBITDA [earnings before interest, taxes, depreciation, and amortization], then it scares investors and buyers" and attracts lower multiples. A report from the seller creates credibility for the seller and confidence on both sides of the table, which can have significant value to potential buyers.
Detractors of Business Value in a Transaction
Weak Management Teams
As much of an asset as the right management can be when it comes time to sell your business, weak management can be an equally strong detractor. "Similarly [to the positive impact of a strong management team], it could detract by a multiple or two of EBITDA versus kind of your typical market valuation," Mike says.
In this context, 'weak' does not necessarily mean 'underperforming' or 'bad at their jobs'; Mike says it is more about "the ability of management to effectively own [the] financials" for whatever reason.
Mike puts it this way: "If there's, let's say, a sole individual owner that is running the business day to day and doesn't want to be involved post transaction, that just limits and narrows the potential pool of investors or buyers." An experienced M&A advisor knows how to help build out financial models from historical data to inform forward-looking projections and budgets – "and at the end of the day, the management team has to take control of that," Mike says. "The CFO needs to … be able to articulate why certain things happen in certain months, whether they're favorable or unfavorable."
High Customer Concentration
"Businesses with significant customer concentration inherently possess more risk and therefore usually trade at lower valuations, all other things being equal," Mike says. Sellers with high customer concentration can mitigate this factor by highlighting long-standing relationships with their key customers. This can be done by generating strong reviews from those customers, issuing blind surveys, or performing third-party market studies to emphasize the great relationship between your company and its key customers.
It Is All About Articulation
No matter how good your financial, management, or customer base looks, your credentials are not worth much if you cannot articulate your business's value enhancers to potential buyers. That is where an M&A advisor comes in.
"We spend an inordinate amount of time working with clients, trying to build what a roadmap looks like in terms of organic growth and M&A," Mike says. "Private equity funds and family offices have been more and more focused on trying to find new platforms … that they can use to then go out and acquire other smaller businesses ... I think that can add a tremendous amount of value" – but only if it is properly showcased.
With an M&A advisor, the transaction process can help you present a clean, truthful, proven case for the value of your business.