value creation

Maximize the Value of Your Company

Value Creation is a strategy that business owners use to maximize the value of their company. Often, business owners are out to create value to sell their company at a high price. A sound transition plan helps business owners realize their exit goals and the tentative time-in-hand for getting their company ready for a sale. They can utilize this time before taking the company to market to maximize the value of their company.

Ten ways to maximize the value of your business:

  1. Identify Areas for Improvement
  2. Get assistance from professionals
  3. Develop a stable management team
  4. Clean up finanical records
  5. Ensure a stable business location
  6. Provide clairity of future growth in earnings and cash flows
  7. Develop strong operating systems
  8. Ensure clear bifurcation of personal and business expenses
  9. Develop solid vendor relationships
  10. Reduce customer concentration issues

Identify Areas for Improvement

A great place to start when deciding on a value creation strategy is to identify the areas you and your company need to improve. This usually takes work from those inside the business and outside of the business.

Get Assistance from Professionals

Business owners should hire the services of an accredited valuation firm and obtain an independent professional valuation of their business. They can also seek guidance from an objective business advisor, who can reveal the strengths and weaknesses of their business by conducting appropriate assessments and audits of systems and procedures.

By identifying the value drivers for their business, owners can increase the value of their companies and ultimately their sale price dramatically.

Business owners should prioritize the weak value drivers of their company as revealed by those assessments and work towards improving them.

Develop a Stable Management Team

Buyers and investors alike seek businesses with management teams to effectively carry out sales, marketing, and product or service delivery.

When owners are involved heavily in daily operations that are key to the business’s health, buyers see it as a substantial risk that will negatively affect value during a valuation of the company. On the contrary, a strong management team that can handle critical matters independently will value a potential buyer highly.

Also, business owners should ensure that the workforce is skilled, efficient, and loyal. Key employees can positively impact the value of a company, especially when buyers are interested in sourcing specific skill sets to enhance their existing business.

Clean Up Financial Records

Companies usually fail due diligence when prospective buyers or lenders find that their financial statements appear sloppy or unreliable. Business owners need to take extra care that their book of accounts is error-free, accurate, and reliable.

For instance, if a business’s revenue exceeds $10 million, owners should consider obtaining audited financials. Audited financials are done in accordance with GAAP, which ensures quality, accurateness, and professionalism. Business owners can also opt for externally reviewed financials, providing a higher degree of quality than internal financials.

Download the Definitive Guide to Business Valuation

Ensure a Stable Business Location

In some businesses (like retail), location plays a pivotal factor in their market value. A change of location after the acquisition or merger could adversely impact the revenue and profits of the organization.

Even when the companies are in the manufacturing or wholesale business, likely, the key employees reside nearby, and changing locations may push loyal employees to look elsewhere — leading to potential risk or losses for investors.

Acquiring companies consider firms with unstable facilities for operations to be risky. Business owners seeking to maximize the value of their business should ensure the stability of the business location for at least three to five years after the sale.

They can explore extended lease options to remove uncertainty without reducing the value of their business. Such arrangements give the business owners the flexibility and not the obligation to extend the lease beyond the current term.

Provide Clarity of Future Growth in Earnings and Cash Flows

Investors are not just interested in a company’s records of earnings, cash flow, and growth. Still, they also seek to purchase a promising business showing clear indications of progress in the future. Business owners looking to maximize the value of their organization need to have a written plan describing how their company can achieve future growth.

The document should have clear indications of which factors will drive future earnings. They could include new product lines, expanding the augmented territory, increasing manufacturing capacity, industry dynamics, etc.

Develop Strong Operating Systems

The strength of a company’s systems, processes, and procedures plays a vital role in improving the value of a business. By planning for the sale early, owners can work on their systems and make them robust enough to pass the assessment that prospective investors will conduct.

Business owners must detach from the procedures and develop them so that their long absence does not impact the efficiency of the systems. Also, owners should empower the management team to handle difficult situations and obstacles without their input.

Business owners can leverage their strong operating systems in potentially negotiating a higher asking price during the sale of their business.

Ensure Clear Bifurcation of Personal and Business Expenses

It is not uncommon for private company owners to include their expenses in the books of the business. However, during the due diligence process, investors consider an abundance of add-backs to earnings a risk.

Uncertainties in financial records can bring the value of a company down during negotiations. To avoid such situations, business owners should proactively minimize personal expenses on their book of accounts to build credibility for their financials.

Develop Solid Vendor Relationships

If the pandemic has taught us anything, it’s that a business dependent on one supplier is vulnerable to significant raw material shortages and disruptions in supply. As such, investors consider having a high reliance on a sole supplier risky, which detracts from value.

On the contrary, a company with a diversified supply chain is seen as a positive factor from an investor’s point of view. Having multiple sources of suppliers of essential inventory and raw materials stabilizes a business’s supply chain.

Reduce Customer Concentration Issues

When investors value a business, they factor in the risk associated with customer concentration. Having high customer concentration (several large clients that drive a preponderance of revenue) can lead to severe dips in revenue if a customer goes in a different direction.

Potential investors see large revenue concentration (20% to 25% or higher) as a red flag. Business owners should actively work to diversify their customer base to combat this risk as much as possible.

How Quantive Can Help

Contact Quantive to see how we fit into your value creation initiatives.

gap analysis

Mind the Gap: Using Valuation for Gap Analysis

Our clients use business valuations for many reasons. Litigation? Check. Underwriting? Yep. Shareholder Agreements? Absolutely. Although, one of the ways we love to see our clients engage our services (and quite frankly we don’t see this reason enough) is for gap analysis.

What Is Gap Analysis

It sounds fancy, right?  As a concept, gap analysis is pretty straightforward.  From Investopedia, Gap Analysis is:

A gap analysis is the process companies use to compare their current performance with their desired, expected performance. This analysis is used to determine whether a company is meeting expectations and using its resources effectively.

Download the Definitive Guide to Business Valuation

Gap analysis consists of:

  1. Listing of characteristic factors (such as attributes, competencies, performance levels) of the present situation (“what is”).
  2. Listing factors needed to achieve future objectives (“what should be”).
  3. Highlighting the gaps that exist and need to be filled.

Gap analysis forces a company to reflect on who it is and ask who they want to be in the future.

Using a Business Valuation for Gap Analysis

As with many things you can think of valuation in terms of a bell curve.  For any given company there is a range of potential valuations.  Certain scenarios will present on the lower end of the curve.  A perfectly average company presents in the middle.  And of course extraordinary companies present at the top end of the value range.

By engaging a firm to perform a business valuation, you are essentially laying the groundwork for establishing the “zero case,” or Vo in our illustration.  The question, then, is how do you move the valuation to reach a higher valuation?  Your valuation analyst can work with you to understand:

  • What factors or risks are present in the company that is holding value down?
  • What actions might the company take to improve value?
  • Are there risk mitigation steps that the company might take to improve value?
  • What will the impact on improved earnings have on value?

Improved Earnings and Reduced Risk: The Double Whammy

One final note.  Working through a gap analysis (which ultimately is often a several-year process) often has the impact of focusing management on risk areas to address and profit potential to improve on.  When you undertake steps to improve profit AND mitigate risk, you are essentially improving your valuation “multiple” AND multiplier.   Your return is more than 1:1.

Example:

Your initial valuation indicated a V0 of $5m.  Your valuation multiple (we hate these but they work for illustration) is 4.0x.  So $1.25m earnings times 4.0x multiple = $5m valuation.  After working through your gap analysis and implementing a plan to improve, you’ve mitigated most of your serious risk factors.  Earnings have improved to $2.0m.  Your valuation multiple has improved to 5.0x.  New valuation? $10m.

Key Takeaways:

  • Gap analysis is the act of comparing a current status to a projected status of a company. This is typically done with a value gap.
  • One can use a business valuation to ensure they are comparing correct numbers. Business owners can also use an analyst to help them answer helpful questions on the next steps.

Using a Valuation for a Shareholder Buyout

Shareholder buyouts occur frequently in closely held businesses and often are costly for parties that feel that the payout is unfair – whether too high or too low.

Triggering events for buyouts happen all the time, yet as a business owner they are often not events you spend time thinking about every day. They include:

  • Retirement of a shareholder
  • Shareholder seeking to exit partnership
  • Death of a shareholder
  • Inability to continue working together
  • Shareholder involved in a divorce

They can also be costly if the ownership interests transferred are not valued properly, primarily due to the time and expense associated with litigating shareholder disputes or resolving transactions with the Internal Revenue Service. Even when a buy-sell agreement exists, it may be prudent for the shareholders to engage the services of a trained and accredited valuation professional.

Valuation professionals help mitigate the risks associated with a shareholder buyout by preparing a supportable, well documented valuation report that is based on a well-defined assignment, comprehensive data gathering, and a thorough analysis of the factors affecting the value of the business. The failure to engage a professional to work through valuation leaves the parties involved open to acrimony, drawn out negotiations, and the potential for costly litigation.

Related: How Shareholder Compensation Affects Value.

Defining the assignment

Confusion and misunderstandings arise in shareholder buyouts when the valuation assignment is not carefully defined between the appraiser and the shareholders for whom the valuation is being prepared.

The most critical aspects of defining the assignment are choosing the appropriate standard of value and properly addressing the impact to value of control and minority interests.

A common standard of value is fair market value, under which a minority interest is valued with the appropriate lack of control and lack of marketability discounts. However, shareholders in a buyout situation may prefer that 100 percent of a company be valued regardless of the ownership interest that will be transferred, since they may be negotiating based on the pro rata value of the entire corporation.

Another standard of value used in shareholder buyouts is fair value, which is commonly used in dissenting shareholder valuations and minority oppression cases. Because fair value is a statutory standard defined by state case law, the business appraiser should further clarify in the engagement letter what discounts will or will not be considered in a valuation under the fair value standard.

Tip: Understanding standards of value is critical, as various discounts for control and marketability can have an enormous impact on the value of the interest appraised.

Gathering the data

Once we have defined the parameters of the assignment the appraiser must gather data, to include both company specific information and industry information. Part of this process normally includes a management interview to both gather data and clarify any of the information provided.

Of concern is access to reliable company data. Depending on the context that the valuation is being performed under, management may have a vested interest in the outcome of the valuation and their answers may be skewed.

A skilled appraiser will determine whether management’s statements makes sense based in context of the company’s within its industry and the market factors that drive the industry.

Analyzing the data

The next step in the appraisal process is for the appraiser to analyze the data gathered and to develop valuation models. An appraiser must ordinarily consider each valuation model or method that is likely to be applicable to the subject company.

Approaches will often include the asset approach involves determining a value indication using the value of the assets of the business less the liabilities. Since the net asset value does not include the intangible value of the company, the asset value will often “set the floor” for any valuation.

The income approach involves ascertaining the value of the future economic benefit stream of the company in today’s dollars. The anticipated benefits are usually based either on historical income statements, adjusted to reflect the ongoing earnings of the business, or forecasted income statements.

Of critical importance is making normalizing adjustments. As small business’ financial statements are often managed to a tax purpose normalizing adjustments are often required to indicate the true economic benefit of ownership. (That being said, minority owners may not always be entitled to such adjustments based on their lack of control. This is a critical point to understand when Defining the Engagement.)

Tip: Normalizing adjustments can have a very large impact on value. Discuss with your valuator if they are appropriate for your situation.

Using the Market Approach, the appraiser will use actual market transactions involving either sales of entire businesses or minority interests. This can provide objective, empirical data for developing value measures that apply to the valuation. This empirical data is critical in valuations for the purpose of shareholder buyouts, because it provides support for values derived under the income approach.

Timing Considerations

Ok, so you get the idea as to how the process works for a shareholder buyout.  But when do you get the valuation?   In our experience shareholders often take a “wait and see” approach, often letting the other party take the lead in pricing discussions.  Negotiating theory tells us that this is a bad move.  But even more importantly, waiting tends to exacerbate the gap between parties – both financially and personally.  More often than not this leads to more strife – which leads to more lawyers, accountants, and valuation folks driving up expense!   With many years working on these matters time and again, we strongly feel that it’s best to be proactive when it comes to getting the valuation completed.

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Conclusion

Even if a shareholder does not agree with the opinion of value, the shareholder is less likely to challenge a comprehensive, well documented valuation report by an accredited professional.

When the shareholders involved in a transaction understand and agree with the valuation process, they are more likely to negotiate successful transactions and avoid potentially costly and lengthy litigation.

Takeaways:

  • What is the standard of value?
  • Fair Market Value, Fair Value, or something else?
  • What Discounts will be taken? What portion of the business will be valued?
  • Involve your analyst early
  • Insure data discovery is robust
  • Avoid the “wait and see” approach!

 

[Updated April 2021] Is the M&A Window Closing ?

Note: We originally published this article in late 2019.  At the time our thinking had been “this has been one heck of a ride… but sooner or later the wheels are going to come off this hot deal market and the economy!”  Well… turns out we were partially correct.  Of course we didn’t see a global pandemic coming – but much of our thinking then is still applicable now.  What’s new though?  The (massive) impact of potential cap gains increases on a transaction.  Let’s dive back in.


The Current M&A Market

Depending on who you ask the M&A market is either totally lit or is… dreadful.  And here is the thing: everyone is right.  Are you working in a space that has been massively, negatively impacted by the pandemic?  You won’t be surprised to learn that the only activity there is in distressed (aka “fire sale”) transaction.  On the other hand in areas that have defended deals are still happening.  I can attest to the fact that the areas we focus (Data Science plays like AI / ML / DL, Cyber Security, and Federal) are all experiencing robust transaction markets.  For healthy companies we are seeing strong multiples and healthy auction environments.

And that’s the thing: a company that was well positioned for a transaction before that has maintained performance is still well positioned.

Which leads me to the headline question: is the M&A market still there, and should I consider selling now?  

(I’m going to save you the pain of the next umpteen paragraphs: short answer is that if you are performing AND you think you MIGHT want to exit in the next few years…. given the tax climate by all means you should roll right now.  But read on for the details!) 

Can You Afford to Sell Right Now?  

First off, this is hands down a generationally best sell side market.  If you want to sell a company and you can afford to, then by all means go to market.  How do you know if you can afford to sell right now? You need to answer two questions: what is the current value of my company?  And how much do I need? The former is best answered by a valuation – it’s a relatively modest investment to get clarity from an independent expert on how the market will price the asset you have built.  The second question should be answered by working with your financial planner. Getting granular on how your financial situation will look after the sale (using your current valuation as likely the largest input to that analysis) will help answer the question.  

Recapping: if what you have (i.e. the current value of your company) exceeds what you need (i.e. the capital that your financial plan requires in order to meet retirement goals), then by all means do-no-pass-go and go to market now.  

What Do I Gain by Waiting?  

For some folks the outcome of the first step will clear: you absolutely cannot afford to go to market. And clarity is great. But what seems to happen more often than not is a gray area. Perhaps the numbers are close but not quite there. That’s not a fun decision framework.

If you are in this category the real question is what do you gain by waiting? I’m constantly saying “the passage of time is not a strategy.” Waiting alone will not fix a value gap – we are already at the peak of the market. Values likely aren’t going to materially increase. Or put another way, there is at least an equal likelihood that values start to decrease.  

With this dynamic in mind, consider this: if you have an actual strategy to grow value and pursue that plan diligently, then waiting may make sense. On the other hand, if you are hoping that the market further matures and delivers a great value for your company… well I’d politely suggest that that isn’t the best strategy.    

Which brings me to taxes.

Impact of Capital Gains on a 2021 Transaction

So you’ve gone through the first decision point and concluded that you can afford to sell.  What happens if you delay that decision a bit?  You potentially face a big tax hit that is 100% out of your control.   For many companies that preponderance of their transaction is taxed at capital gains rates vs. ordinary income.  I’m going to do some rounding here (forgive me in advance if you are a tax person reading this) – but that currently means about a 20% tax rate.

The current proposals would bring that rate to ordinary income rates- ie approaching 40%. I.e. double the current rate.   My money is on it not going quite that high…. but on moving up significantly from the current rate.  So with that said assuming that the rate increase isn’t retroactive…. why on earth wait until AFTER that increase?  For all intents it’s found money to do a deal now.

So recapping – if you can afford to sell and want to… now is the time to go to market.  Waiting will likely move the goal posts on post-tax proceeds.

What is the Probability of Success?

Let’s assume that you decide to pursue a value growth strategy to close your value gap. How confident are you that you can execute on plan?  

Similarly, entrepreneurs are constantly chasing the next big thing. We all do this – the next big project, the upcoming contract win, or maybe the new product launch. Healthy businesses always have a next new thing- it’s what feeds the beast and underpins growth. But that same cycle can feel like a hamster wheel with owners constantly chasing the next increment of success.   

In either case, it’s time to start handicapping the likelihood of successful execution. On our end, when we work with clients on value engineering assignments we do just that: by correlating actual impacts to enterprise value to both the probability of success and time to execution we can start to understand how value might change over time.  For instance, a given initiative might result in an additional $250k of income, require 18 months of time, and have a high likelihood of success. If the market currently would value that company at 5x, that initiative is worth $1.25M in enterprise value.  

What is the Probability that the Market Turns First?

Of course all this assumes that we have time to execute.  The market, being a nebulous collection of individual participants, doesn’t care about our plans whatsoever.  Take our example from above. What would happen if you executed on plan and in 18 months … but the market turns and now prices the company at a 4x? Well… it’s not going to feel good, that’s for sure. See below: 

In our example – that quarter million dollars of hard fought gains would yield exactly zero dollars in improved enterprise value in a market downturn. That’s not to say it’s not a worthy project – the company would still be delivering those earnings back to shareholders. But in terms of pursuing a sale you very well could be literally missing the market.  

Takeaways

We are always talking about how “timeline is everything.” If you have a short term horizon you can only impact so many things. Your decision to go to market now means you aren’t going to massively increase enterprise value suddenly. And that’s okay if the numbers work for you – it’s a great market! If you do decide you need to wait – be it for that next big win or to put in some hard work – that’s okay too. Just understand that you are on the clock and that a market downturn may erase the gains you’ve been holding out for. Finally, if you run the numbers and realize that you need to grow value beyond what can reasonably be expected in the short-term then it’s time to buckle in for the next 3-5 years and enjoy the ride.  

Need some help working on this decision matrix? Drop us a line.

Reminder: State of M&A Webinar Tomorrow

Last Call! Register Here….

I’ll just go ahead and skip all the trite pleasantries about how we are in the “new normal” and get right to it: are you curious what is going on with M&A deals? I mean… it’s been quite a year, right?

It’s been nearly one year exactly since I wrote “Is the M&A Window Closing?” And it’s now going on 6 months since I did a whole host of webinars and events on “M&A and COVID.” When I wrote the “Window is Closing” article, my biggest concern at the time was not a specific threat to the M&A market – rather a general sense of foreboding that this market is just too good to be true. (Wishing I had taken the odds on “global pandemic” being the thing that tumbles the economy….)

In any event, the market has definitely changed. On one hand, M&A deals are still happening! On the other… a lot depends on the industry and the health of the target company. And even in those industries that remain healthy the logistics of running a “process,” interacting with buyers / sellers, and diligence has often materially changed. We’ll be discussing those issues and more with a few industry experts.

Speakers

We’re super happy to have Dean Nordlinger from Blank Rome and Stuart Smith from Wilmington Trust joining us on this panel!

Dean Nordlinger has more than 20 years of experience representing small and medium-sized privately held companies, closely held businesses, private equity firms, and entrepreneurs across various industries, including government contracting, media and communications, information technology, and manufacturing. He regularly represents clients on business and corporate matters in all phases of their business lifecycle—from start-up to sale of the company.

 


Stuart Smith III leads strategic family business advisory services at Wilmington Trust and serves as the National Director – Business Value Strategies for M&T Emerald Advisory Services TM. In that capacity, he collaborates with planning and wealth management colleagues to develop comprehensive, holistic strategies and solutions for clients and prospects with family business holdings.

Upcoming “State of M&A” Webinar

BLUF: We have an upcoming webinar on the current State of M&A. Please shoot us a note if you have topics in mind you’d like us to cover

I’ll just go ahead and skip all the trite pleasantries about how we are in the “new normal” and get right to it: are you curious what is going on with M&A deals? I mean… it’s been quite a year, right?

It’s been nearly one year exactly since I wrote “Is the M&A Window Closing?” And it’s now going on 6 months since I did a whole host of webinars and events on “M&A and COVID.” When I wrote the “Window is Closing” article, my biggest concern at the time was not a specific threat to the M&A market – rather a general sense of foreboding that this market is just too good to be true. (Wishing I had taken the odds on “global pandemic” being the thing that tumbles the economy….)

In any event, the market has definitely changed. On one hand, M&A deals are still happening! On the other… a lot depends on the industry and the health of the target company. And even in those industries that remain healthy the logistics of running a “process,” interacting with buyers / sellers, and diligence has often materially changed. We’ll be discussing those issues and more with a few industry experts.

Stand by for event logistics / registration!

COVID using a FCFO for cash flow forecasting

COVID-19 and Outsourcing Accounting

We are receiving a lot of requests from companies that are looking for outsourcing some or all of their internal accounting during the COVID-19 crisis. First, we are feeling the pain too, and definitely get where you are coming from. Second, from a work process and technology perspective we are well positioned to support. We’ve traditionally supported most of these assignments remotely, and we’re prepared to help.

If you’ve found yourself in the difficult position of reducing in-house overhead staff, please reach out to schedule a no-cost consultation.

Webinar: COVID, M&A and Valuations

Based on the the number of people asking questions regarding what COVID means for M&A, their valuations, and buying or selling a company, we thought a webinar was probably in order. We’ve got two dates coming up:

– 3/19 @ 11:30AM EST – Register Here https://hubs.ly/H0nFB4t0

– 3/24 @ 11:30AM EST – Register here https://hubs.ly/H0nFB3W0

Quantive’s Dan Doran will be leading both sessions (and both will be the same content – so pick your poison). Dan will present a few different playbooks to address:

– What should I do if I’m currently on the market?
– What should my decision matrix look like if I *wanted* to go to market this year?
– How will COVID impact my valuation?
– If my exit is on hold, how should I think about positioning / defending / growing value in the meantime?

Hope to catch you there….

Quantive’s Dan Doran Wins 2019 Exit Planner of the Year!

This year at Exit Planning Institute‘s 2019 Excellence in Exit Planning Awards, Dan Doran was awarded Exit Planner of the Year! This award is named after EPI cofounder, Peter Christman, and is the highest honor that you can receive in the exit planning industry. Please join us in congratulating Dan on such a fantastic achievement!

Read on to find EPI‘s take on Doran winning the Exit Planner of the Year award:

“It is awarded to a CEPA who can be directly tied to changing outcomes for business owners and leading advisors. This advisor makes significant contributions to the industry, exemplifies the core values and characteristics of EPI and the CEPA designation, while making a uniquely significant impact on the larger exit planning profession on a local, regional, national and/or international scale. Doran earned the CEPA designation in 2016 and has since become pivotal member of the CEPA faculty, EPI Capital Region chapter president and launched the EPI Rocky Mountain chapter. He is dedicated to engineering a road map for his clients in order to produce the outcome they desire.”

Congratulations to Joseph Strazzeri for winning 2019 Leader of the Year and to Vincent Mastrovito for winning 2019 Member of the Year!