"Market Value", or commonly referred to as "Fair Market Value" of a business, is defined as what a willing buyer and a willing seller agree upon under normal circumstances. If agreement becomes the common denominator of fair market value, what is measured becomes the fuel for the negotiation.
What a business may bring on the open market will vary based upon a number of critical factors. These factors are the overall makeup of an enterprise that ultimately measures risk and converts it back into market value based on an acquirer’s faculty. Proper alignment of the following key areas will stoke the fire, so to speak, as it relates to the value and health of an organization: Profitability, Record Keeping, Legal Entity, Show and Tell, Organization, Revenue Source, Intangibles, Third Party Controls, Environmental, and Succession.
1. Profitability: Surprise! Buyers want to make money. They have a choice of investment opportunities and expect a rate of return above their minimum threshold. It may make sense that as a company’s profits increase, the more valuable the entity becomes. While this is true, what may not have been quantified is that not all earnings bring in the same value.
Companies that have to start over with new customers weekly, monthly or yearly will bring in less value than a business that has recurring revenues from the same loyal diversified customer base. An example of this is revenues and profits that come in from products that are consumable like beverages or yearly maintenance agreements on machinery. Look for ways to diversify revenues. If a company currently installs signs, it may want to consider adding lighting maintenance as well. The more entrenched in your customer’s survival, the more valuable you become to them and the marketplace.
2. Record Keeping: If they can’t find it, they won’t come! Private businesses tend to use accounting methods that minimize taxes, whereas public companies want to maximize their earnings. The answer is not to pay more taxes, but to keep adequate records so that non-reoccurring expenses can be located and added back to the company’s earnings to reflect the company’s true profitability. Being too aggressive on deducting personal expenses, such as fuel and repairs for all family vehicles, these expenses may not be identifiable on your financial records, and could cost you lost business value in the future.
Good record keeping should be practiced even if you’re not thinking about selling now. It is always a good idea, as most buyers and lenders tend to look back at the financial records of the business for up to five years.
3. Legal Entity: Do not be misinformed … not all legal structures are equal. Ask yourself why your business entity is set up the way it is. Many business owners have had their business set up based on past circumstances or expectations.
For example, let’s say Joe started a business in 1982 as a hobby out of his garage making golf clubs for his friends and family. Joe wanted to incorporate to protect his assets and for tax purposes. His advisors set up his corporation and opted not to take the "S" corporation election. Joe thought this was fine, as he did not expect his business to get very big or have much value. As it turns out, Joe’s business takes off and is now making $5,000,000 in profits per year after Joe has taken almost the same in salary and perks.
Joe decides to retire and sell his business and calls in a professional to represent him. After review, the intermediary asks Joe why his business was a "C" corporation and Joe can’t remember. Joe is informed that because his corporation pays taxes before it can pass though profits or sale proceeds, that his share of taxes on the sale would amount to as much as 60 percent of the sale price, due to double taxation. Joe is also informed that due to the profit level his company was producing, if he would have converted his corporation 10 years ago to an ‘S" corporation, he would not have the double tax issue on the sale of his business and would have saved as much as $1,500,000 in corporate income taxes per year.
The entity you choose may take dollars out of your pocket, so with all you’re getting, get understanding.
4. Show and Tell: How your company looks and feels will set the tone on whether your business makes a statement of excellence or "we are not sure how we got here." Setting up budgets and doing routine maintenance shows that you take what you do and how you do it seriously. This is the difference between someone purchasing a fixer upper and a smooth running machine, not to put aside what your customers may or may not think.
5. Organization: Not just people, but the right people, are important to an organization. It may have crossed your mind, "What if I train them and they leave to another job?" While that is a legitimate fear for many employers, the question should be "What if you do not train them and they stay?" How important the ownership is to an organization will increase or decrease the company’s market value. To increase your business’ value and reduce risk, have a goal to increase your management team to be able to run and grow the company without you. This takes time, money and planning but the reward is well worth the effort.
6. Revenue Source: One customer today could mean no customer tomorrow. The more you can diversify your customer base, the less volatile you become. If you have customers that equate to more than 15 percent of your revenues, you should take action. A healthy company may have some large customers but when they dominate your business, it could also mean lower margins. Customer concentration diminishes value, increases risk and sometimes wipes out a whole company.
7. Intangibles: What may be able to be transferred could decrease value. Take the time now to ensure that your intellectual properties such as copyrights, trademarks, patents, etc. are transferable. What may appear to be yours may not always be so. If a buyer has doubts, it could not only delay a transaction but also become the demise of it.
8. Third Party Controls: What is controlled by others puts you at risk. Facility leases, franchise agreements, distributor agreements, and licensee agreements, etc. all have a commonality … other parties’ interests. These interests often have a different agenda than yours. Some tips when re-negotiating extensions or new agreements: 1. Try to limit guarantees to your corporation. 2. Try to gain the longest term possible (10+ years) using options based on quantified risk. 3. Give yourself outs based on unrealized performance. 4. Put caps on participation clauses when possible. 5. Make sure agreements are transferable with reasonable restrictions and without a continued guarantee.
9. Environmental: Start early, do your homework. If your business uses toxic chemicals, make sure no contamination is present. Waiting until you desire to sell may erode value as well as delay a transaction. If your company does not deal with hazardous materials, you may still want to inquire what the property was used for in the past. Whether or not you are responsible may not be the only factor to consider, a potential move or business interruption may also be costly.
10. Succession: Start with the end in mind. Most business owners desire that a family member, current management or other shareholders end up with the company in the end. Studies have shown that only 5 percent of businesses transition to the above due to timing, desire and finances. Have a strong back up in mind, and grow and nurture your company to fit in with a synergistic financial or lifestyle acquirer. As your thinking changes, management, markets or growth opportunities may take on a new perspective.
To learn how your company can benefit and best position itself within the M&A landscape, call or email me now to receive 3 hours of free consultative analysis. Our analysis offers clarity, based on your objectives, if a full or partial exit, recapitalization, divestiture, acquisition or pre-sale exit strategy provides the greatest benefit to you and your company.
Vercor has been delivering M&A expertise for over 25 years. We serve as a trusted partner to help build long term, iterative strategies that ensure you are positioned to meet your unique personal and financial goals whether it is selling, recapitalizing, acquiring or divesting of a division. Now is the time to evaluate, strengthen, prepare and increase the market value of your company regardless of your timeframe.
Todd Cummiskey
Vercor
704-926-6564
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