You think it may be time to put your
business up for sale and retire. But
how do you know if the time is right? Is your business in good enough
shape to be attractive on the market? Is
it turning a profit and are all of your
books in order?
“You need to understand how businesses are valued in today’s business
environment,” says Vince Garozzo, an
officer in the corporate practice group
and a member of the board of directors
at Greensfelder, Hemker & Gale, P.C.
“All businesses are valued based upon
the quality of cash flow they generate.”
Smart Business spoke to Garozzo about
what should be done to make sure a business is ready to be listed on the market.
How do business owners know their businesses are ready to be put on the market?
Business owners need to focus on
improving and enhancing the sustainability of their cash flow. One way to do that
is by generating more revenue, but
another way is to manage the expenses
and the growth of the company.
Most companies are valued and sold
based upon a multiple of their cash
flows. In today’s environment, such multiples could be anywhere from five to
seven times, depending upon the nature
of the business. Sometimes, with a
sophisticated technology company with
a lot of potential growth, you could be
talking about a multiple as high as 10 to
12 times cash flow. In particular, publicly
traded buyers look for middle-market
companies that are closely held and the
founder (or next generation) is examining diversification alternatives. As their
stock may be trading at 15 to 20 times
earnings, it makes economic sense for
them to buy a company on a valuation
equal to five to seven times cash flow,
drop it onto their own bottom line and
watch the accretion to their stock price.
How does the market look right now?
In today’s environment and due largely
to the subprime meltdown over the summer, most of the active purchasers today are strategic buyers looking to make
complementary acquisitions within their
industry. These strategic buyers could be
publicly traded or closely held, and may,
in fact, be portfolio companies of existing private equity groups. Nonetheless,
credit is much more difficult to attract
under current market conditions, and
leverage ratios are being ratcheted
down, which has caused a decrease in
the multiple of cash flow that a buyer is
willing to pay. Consequently, it is currently a buyer’s market.
So what can business owners do?
Basically, they need to analyze the
quality and sustainability of cash flow
and eliminate all unnecessary and related party expenses that a buyer would
not otherwise incur on a post-sale basis.
For example, many closely held business owners pay themselves a significant salary and bonus. A strategic buyer
may very well eliminate the owner’s
compensation and replace him or her
with a manager earning a substantially
lesser amount. You may be better off to
show earnings at an arm’s length management-level employee as opposed to
showing an owner pulling out $500,000 a
year as compensation. Especially if the
company is a S Corporation or a LLC,
where the earnings all flow to the owner
anyway.
It’s also important to have a sustainable cash flow that is diversified. A
buyer would rather buy a company that
has 20 different customers that each
make up 5 percent of total revenue as
opposed to three customers that make
up 33 percent each of total revenue.
Do business owners need to make repairs
before a sale like a residential owner would?
There are many ways to make your
company more appealing. One is to get
your financial statements audited by an
independent accounting firm. All buyers
like to see audited financial statements
of the companies they are reviewing. If
you are reviewing a company generating
$5 to $10 million in revenue, an audit
might be too expensive. A company generating revenue in excess of $10 million
generally should have its financial statements audited in order to provide more
credibility to its financial statements and
its earnings.
You also need to self-audit all of your
contracts, licenses and intellectual
property. You analyze and catalog what
you have and make sure that it’s in a
written format. If possible, it is always
ideal to avoid change of control provisions in contracts, so if you sell the
stock of the company, you don’t have to
get the consent of the customer to close
the transaction. Further, intellectual
property is important because it provides another opportunity for the buyer
to identify a continuing and sustainable
earnings stream, and with the brand that
is being purchased.
VINCE GAROZZO is an officer in the corporate practice group, specializing in mergers and acquisitions and corporate finance, and a
member of the board of directors at Greensfelder, Hemker & Gale, P.C. Reach him at (314) 516-2624.
