What are your goals for exiting your business? Will you need cash for your retirement? Do you plan to leave it to your children? Do you sell it to a competitor or your employees? Whatever your goals, it is important to start planning for the future now.
“Every owner should know the value of his or her business and have an exit strategy,” says John T. Alfonsi, CPA/ABV, CVA, CFE, a partner with Cendrowski Selecky PC, Bloomfield Hills. “Whether trying to minimize estate and gift taxes on a transfer to family members or reduce income taxes on a sale, the owner’s objective is to maximize value.”
Smart Business asked Alfonsi how owners can start focusing on value now to prepare for a successful outcome in the future.
What are value drivers, and why are they important to a company?
Value drivers are areas that have an effect on a business’s value they enhance or preserve the value of the business and are unique for every business. While earnings before interest, depreciation, taxes and amortization (EBIDTA) or cash flow is important, it is not the only area to focus on. Value drivers impact an entity’s multiple and include such things as having a unique product or service. What differentiates you from competitors? Do you have something another company can’t create or is difficult to reproduce? A patent? A copyright? A coveted location? Unique distribution channels? Employees or work force in place can be a value driver for a service-oriented business. Do you have a skilled team in place in an industry where there is a high demand for talent?
What is a multiple, and how is it used to determine value?
EBIDTA is a close marker in regard to cash flow. Cash flow is a driving factor when valuing a business but so is the ‘multiple’ that someone is willing to pay for your business. A multiple is the inverse of a discount or capitalization rate that reflects the risks inherent in a business or what the acquirer perceives as risk. The lower the risk, the higher the value; the higher the risk, the lower the value.
Say your company generates $1 million of EBIDTA. Depending on the company’s value drivers, a seller might be willing to pay four to six times EBIDTA for your business. So the selling price could range from $4 million to $6 million. What moves the price from the $4 million to the $6 million? The nonmonetary factors.
How should an owner evaluate these non-monetary factors?
Make sure cash flow is existent and consistent, but look at all the factors a potential buyer would examine, as well. Of these, the most important may be strategic fit. Oftentimes, a purchaser is a competitor. How would your business fit with the purchaser’s? What do you have that would be difficult for the purchaser to get without obtaining your business?
Other factors include:
Management A business that is highly reliant on one owner will probably be worth less than one with a strong management team in place. Far too many times we see businesses reliant on one owner. There may be good ‘lieutenants’ in place that could continue to function without the owner but not as effectively as they had with the owner at the helm (either due to the loss of the owner’s personal relationships and/or his or her unique knowledge). Owners should start grooming employees to take over in the future. If you have good people in place, offer them incentives to stay with the company.
Customer diversity Your business should not rely solely on one key customer. Any single customer that represents more than 10 percent of revenue and/or profits may be viewed negatively. What happens if the customer is no longer there?
Recurring revenue stream Long-term contracts are more predictable than those that go from year to year, month to month or job to job. They pose less risk and, therefore, create higher value.
Perceived industry leaders Being perceived as an industry leader creates higher value. Get in front of the media however you can. Get quoted in articles in trade magazines, write a column about your area of expertise, go on a local radio talk show, be active in the community.
Have a strategic plan Many small businesses overlook this, as do some larger, too. Your strategic plan doesn’t have to be long, but it should list your goals and provide a focus for the company. Where are you headed? What initiatives are in place to make your plan a reality? This will show that your business is focused, that you know where you’re going and that you have taken steps to achieve your goals.
JOHN T. ALFONSI, CPA/ABV, CVA, CFE, is a partner with Cendrowski Selecky PC, Bloomfield Hills. Reach him at (248) 540-5760 or firstname.lastname@example.org.