At Third Road Management we have the honor of working with businesses and non-profits across a spectrum of industries, ownership structures, tenure and financial status. Through our experience we have gathered some wisdom that can hopefully be helpful to business leaders outside of our current network of clients. This is our venue to share some of our ideas.
Today’s topic is as follows…every business owner contemplates what their ultimate exit strategy is going to be for their business. For the majority of business owners the focus is upon maximizing the valuation of the business to capture their long-term investment of time and money in the business they built to provide retirement security. But how does a business owner maximize the value of the business?
At Third Road Management we have the benefit of both being highly experienced in operating small to mid-sized businesses as well as being well-versed in mergers and acquisitions. More specifically, within the mergers and acquisitions market we have a keen understanding of what both the purchasers of businesses, as well as the lenders that finance the acquisitions, are looking for.
If you, a family member or a friend are considering selling a business in the next 3+ years, here are 5 steps to take that we would strongly recommend considering now:
- Prepare at Least 3 Years in Advance: Both equity investors and lenders alike desire stability, and that stability comes with a track record of at least three years of strong financial and operational performance. If the items listed in steps 2-5 below are done just before a sale, it is certainly better than not doing them at all; however, the value of your business will be better if you can demonstrate a longer-term record of execution. We recommend at least 3 years if feasible.
- Clean Up Your Accounting: We can’t emphasize this enough. No sophisticated investor is going to want to pay maximum price for a business that has a bunch of yellow and red flags from an accounting perspective that lead to non-transparency of results. There are many areas that we can point to help in this regard, but here are a few that are top of mind:
- Adopt at least some accrual based accounting principles. You don’t necessarily have to go through a full independent audit (although it certainly would not hurt) or be fully compliant with GAAP in the United States, but you should strongly consider adopting at least some accounting policies that help to more accurately reflect the performance of the business monthly and annually. Examples would include a proper depreciation schedule, accruing income and expenses (including payroll, expenses paid annually or periodically like insurance, etc), setting up income tax accruals, among others.
- Properly separate your cost of goods sold and selling, general and administrative expenses and allocate some expenses across those as needed and prudent (eg- rent). This will signal to investors that you are keeping a keen eye on business performance and have awareness of aggregate gross margins and operating margins within your business.
- Do not co-mingle income or expenses from other business interests. If you have two separate businesses, keep them separate and have different books and tax returns…unless they are complimentary businesses that can be sold together of course.
- Keep personal expenses out of the business. Stay with us here, but keep your personal car expenses, gas, meals, gym memberships, country clubs, etc. out of the business. While you may be experience short-term tax benefits from those (if they can be justified as a business expense), the reality is that these expenses are reducing the cash flow of your business. Since investors pay and lenders lend largely based on a multiple of those cash flows, and they are unlikely to provide you with an “add-back” for them, we suggest eliminating them from the company’s books.
- If you manage inventory, adopt a good inventory management system that helps you accurately account for what items are on hand. This will provide a greater amount of assurance to investors that you maintain tight controls over business operations.
- Get Lean: Review all areas of expenses to determine whether or not there are opportunities to trim down and make sure that you’re achieving the maximum ROI possible on spending. Possible areas to consider include, among others: rent/ mortgage expenses, utilities, insurance, payroll (conduct a compensation study to determine if you’re currently paying at or above market), outsourcing (IT, HR, marketing, accounting, temporary labor, etc.), raw material purchasing, and pretty much every cost on the profit and loss statement. The caveat to this process is to make sure that any moves are not detrimental to the on-going healthy operations of the business in that they hurt more than help.
- Mitigate Business Risks: Investors love buying businesses that have worked towards mitigating risks that could be connected to the business. Here are some ideas to start with:
- Eliminate or reduce customer or vendor concentrations. Preferably you do not want more than 10% concentrations in either and ideally as low as possible.
- If possible, create contracts with customers that provide a pathway towards recurring revenue streams.
- Have key employees and sales personnel agree to reasonable non-compete/ non-solicit agreements.
- Put in place tight credit and collection policies for customers and favorable terms with vendors to demonstrate strong working capital management.
- Produce an updated HR policy manual that all employees have signed annually, as well as well documented employee files.
- Undergo a voluntary mock OSHA inspection and put into place the proper precautions and policies to mitigate risks of workplace injury.
- Ensure that technology/IT solutions are up-to-date and reduce the risk of business interruption.
- Get Yourself Out of the Business: We have covered this topic in other blog posts, but one of the best things that you can do to create value in your business is to get out of it. The reason is that if the business requires your presence to be successful it is far less appealing to investors, which will drive down the price that someone is willing to pay for it. Key points here are:
- Document everything that is “in your brain.”
- Assign responsibility for client relationships to others on your sales/ customer service team and help them grow in those relationships.
- Give away the power and control by letting others in leadership make decisions.
- At the end of the day ask yourself, “Can this business run without me?” and if not, fix any reason why it can’t.
The above is not a completely exhaustive list and each business is unique and requires more personalized attention; however, we thought that this would be a good way of sharing some information as a starting point. At Third Road Management our expertise lies in everything listed above, so if you need any help always feel free to contact us at firstname.lastname@example.org for a no-obligation or initial cost consultation.