Value Drivers

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Hopefully you’ve read the recent posts regarding the value of businesses and the impact the owner’s actions have on business value. If not, you can review the posts here on the Apex Blog. If you have clients and/or friends who are business owners, please pass along to them.

I recently read a great article with some similar information from a trusted journalistic source, The Wall Street Journal, that confirms what we have been saying.

Enjoy the read and have a great holiday weekend.

Value Drivers: Revenue Trends

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upwardtrendBuy Low – Sell High: This practice makes sense with investments and it makes sense when thinking of your business value. If you started the business from scratch, hopefully it has been built up to a profitable venture and you have plenty of equity. If you bought a business and have increased it revenue and profitability, most likely you have increased the overall value of the business (as you have read in past blogs, there are other variables to consider).

What most people are looking for when buying a business are the revenue trends over the last 3-5 years. If the revenues are stable or growing – great. If they are in decline, we need to understand the reasons for it. The reasons for the decline might keep a buyer interested, however, there are more perceived risks associated with a downward trend. This will prove to be a negative impact on business value. One of the other difficulties in selling a business with downward trends: banks willing to finance a business in this situation are an endangered (maybe extinct) species, forcing the seller to become the lender.

Many times we see business owners pass up the opportunity to sell at the high point, and who are instead pressed into selling at the worst time due to age and health concerns. An owner who decides to keep working into their 80’s inspires many of their family, friends, and peers. I’m sure any of us would feel blessed to be able to do that. But too often those companies lose momentum as the owner loses energy and passion and we end up with a distressed business.

Buyers want good businesses with strong trends and business owners can get more for their business when they exhibit strong revenue trends. Hmmm, seems like a winning combination!

Negotiation as a Seller

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SellerNegotiationSome of the sellers we have worked with have the approach that “it’s all or nothing. You WANT my business, you SHOULD want my business and I don’t NEED to negotiate.” Yikes!

Business peers, friends and family might be saying that their business is worth $2 million when the financial statements and other variables show it is really worth about $1 million. The seller can get a lot of advice from people that either don’t understand the situation, don’t have all the details, or have motivations that conflict with the reasonable price for the business. A seller shouldn’t get a price locked into their brain without room for negotiation. There is normally give and take when any deal is done and flexibility is how it happens.

Another important concept is listing age. Some sellers think that there will be a never ending line of prospective buyers. However, the amount of time that a business is on the market can affect buyer interest (and value!). We know this from so many years of doing deals. The first two to three months on the market are critical for buyer activity.

We use a real estate market analogy. A house that is on the market for 4 – 6 weeks usually has a dwindling number of showings because there is an unspoken concern that something is wrong with the house or that it is priced too high. (And I don’t want to be the idiot that buys it.) So proper pricing is critical to get buyers interested and willing to negotiate.

Bottom Line: In order to get your business sold, the business needs to be priced reasonably, and there needs to be give and take. Sellers need to have a good idea of what they really want from the deal and have some room to negotiate. If you or someone you know needs an honest assessment, please talk to one of our Apex Business Advisors.

Value Drivers: Clean and Accurate Financials (Part II)

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Clean and AccurateCurrent Financial position and historical records are the major factors in putting a value on a business. Last week the focus came down to trust issues around the financials. This week we’ll focus on the numbers.

Definition of Cash Flow: owner salary, net profit, depreciation, interest expense, and discretionary expenses not necessary for continuing operations

As mentioned in last week’s blog, the typical business advisor (accountant, financial planner, attorney, banker, business coach, etc.) needs to understand the existing situation and historical information to unlock some mysteries in the business. What are the trends, opportunities, threats? Solid financial information should lead to solid advice.

When selling a business, the marketplace puts a value on the cash flow of the business. Have the cash flows been steady, increasing, or decreasing? Are the cash flows readily apparent in the financial statements? Is the cash flow expected to continue or are there major changes expected? A buyer needs to understand the cash flow in order to make a good offer on a business. That offer takes the following into consideration:

1. Return on the buyer’s initial investment (paying the new owner’s salary),

2. Cash to pay off debt for the acquisition, and

3. Retaining cash in the business to support operations.

A business that shows a cash flow of $100,000 may be able to achieve a market value of 2 or 3 times that amount. Let’s say the value is $300,000 (3x $100,000). Last week I used an example of someone sending a family of 15 on a European vacation. Let’s say that the tax deduction used for that vacation was $25,000, and the tax savings was approximately $7,500. It feels good to save $7,500 on taxes; however, the value of the business went down considerably more than that. A $25,000 expense translates into lost business value of 3 x $25,000, or $75,000!

Sure, there is negotiation, and this is just a simple situation that should be easy to explain to the buyer and the bank. It does illustrate a point, however, that some simple tax dodges to save a few bucks will certainly make a much larger reduction in business value.

Talk to one of our Apex Business Advisors to help you plan and improve the value of your business before it is time to sell.

Value Drivers: Clean and Accurate Financial Information

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messy deskOne of the biggest struggles we have with our entrepreneur clients is that they have lousy financial statements. Many times it’s from lack of caring and know-how, but sometimes it’s done intentionally.

How does a professional advisor, such as a banker, lawyer, accountant, or business broker advise their client when the business financials consist of a check book and a box of receipts? Or the situation where the business owner has one cash register that isn’t connected to the accounting system (because that one is for unrecorded cash), or the owner runs all personal shopping through the business, or takes a family of 15 on a European vacation on the business, or doesn’t use an accountant or bookkeeper at all? The company’s tax return doesn’t resemble (in the slightest) the profit and loss statements and balance sheets. The examples of poor record keeping and tax dodges that we see go on and on.

Let’s focus on the value of the business based on quality of financial statements for this blog. As mentioned above, advisors are hard pressed to advise a client that has poor financials. We need to see revenue and margin trends, the relevant expenses, cash flow, sales by customer, liquidity, and much more. We need to know the true picture to know how the business compares to similar businesses in the industry, to recognize trouble spots, to find opportunities, to budget, and to plan an eventual exit.

The Exit: When a business is entertaining a potential buyer, will the buyer see a true picture of the business immediately or will they have to dig for the truth? The more they have to dig, the less trust they will have in the management (and the value of the business just went down). Will the buyer see a concerted effort to avoid paying taxes? What else might the seller be hiding? Can the buyer trust the seller (and the value of the business just went down)?

In most situations the buyer needs a bank to fund an acquisition. Banks don’t trust anything other than the tax return (and for good reason). You can see where this is going, can’t you? The bank doesn’t like the financials because they don’t match the tax returns, the tax returns don’t show enough cash flow so they tell the buyer that he is paying too much for the business (and the value of the business just got reduced again!).

Having accurate financial statements is not difficult, but it does take some focus and action. If you need help with getting your books in order, Apex Business Advisors can direct you to a local professional. It’s ok to ask for help!

Value Drivers: Business Owner Who Works in the Business

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workinginthebusinessOver the next several weeks you will read about keys to business value.  These are some basic drivers that will make your business or the business you are pursuing, more (or less) valuable. We are talking about the attractiveness to a potential buyer in an open market.  Disclaimer: There are lots of different things that can impact the value of a business – and we won’t cover them all.

Sure there are times when some of these drivers don’t impact the value of the business – like if you find a gullible buyer, family member that will be taking it over, a strategic buyer that may focus on only one driver, etc. However, a business owner can’t rely on these buyers to be there when it’s time to sell the business, so it’s better to make the business more appealing to a broad market.

This week the focus is on a Business Owner Who Works in the Business. The alternative is the owner that is working on the business.  If the owner is working in the business, i.e., driving the truck, running the machinery, or making the sales calls, then the potential buyer pool has been shrunk to those who can fill those shoes, and fill them well. A potential buyer would have to possess the same technical expertise of the current owner.

You’ve probably heard the adage “Work on the business, not in the business.” There are good reasons why consultants and professional advisors repeat this. First of all, if you are working in the business, you will get really tired and not be able to put energy into growing and enhancing the business. (The E-Myth, by Michael E. Gerber, has some good examples of how working in the business can bring it down.) The impact on business value is dramatic. Is a buyer of the business buying a job – or buying a system, a brand, a process, etc.? We do have buyers that are interested in “buying a job”, but they are a small population and are also very selective.

Call your Apex Business Advisor for more information.

Interest Rates are Low and Banks Are More Aggressive

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BankerThrowingMoneyWe spent the better part of 2009 and 2010 trying to chase bankers who were not returning phone calls. There were many banks changing hands and were not able to pursue loans for business acquisitions. Over the last year, we have witnessed banks being more “aggressive” in seeking business clients. They have money that they need to loan and they are looking to Apex for deals to fund. Bankers are not throwing money around, and they are still conservative. However, they need to make loans to be profitable.

The interest rate for a 10 year, business acquisition loan is as low as 5.5%. This is about the lowest rate that we have ever seen. We have done quite a bit of business with Wells Fargo and there is a lot of good information about SBA loans here.

These two factors, aggressive banks and low interest rates, are creating an environment where deals are getting done. The people that will gain the most are business owners needing working capital and equipment loans, and for buyers of businesses that need to borrow money to fund an acquisition.

An important part of our job as advisor is to help you find funding for your deal and working with the banks to get them the information they need to make good decisions. Call one of our brokers today to learn more.

Fitting the Pieces Together – A Recent Success Story

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SuccessStory-PuttingPiecesTogetherWe enjoy sharing success stories about the buyers and sellers that we work with. We had a business owner with a technology based company that wanted to sell. They were asking $950K for the business based on the current revenue stream. (This was all happening in the middle of 2011.) Potential investors were concerned that the core technology might be outdated, so they kept passing on the opportunity.

The seller continued growing the business through new implementations of the technology. Over the next six months, they also bought a competitor. (Interestingly, our buyers had a chance at that business as well, but passed again because they were still nervous about the technology.)

Fast forward to January 2012. The asking price went from $950K to $1.9M because of the acquisition and overall increase in revenue. The increased asking price was justified based on performance. The happy ending is that the seller just accepted an offer for close to the full asking price.

Everyone wins in this story:

The seller had bought the business with a plan to grow it and sell it for a profit. Accomplished.

The buyer had been looking for a business for 4 years. It is a husband and wife team that really liked the clean cash flow and growth potential of the business. They had experience with the core technology and are excited to own and grow their own business. Success.

Connecting buyers and sellers so that everyone wins is what we do best. If you are on either side of that equation, we would love the chance to talk about how we can help.

Capital Gains Taxes Set to Raise in 2013

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Capital-Gains-Taxes-Are-Going-Up-SMALLERCapital gains taxes will be going up from 15% to potentially 25% in 2013. If you are doing a deal that is valued at $1M, that can make a big difference in what you are able to put in the bank after selling your business to the tune of $100K. If you are close to retirement or thinking about selling your business, you should move aggressively to prepare your business. You will realize a substantial savings if you close by December 31st of 2012.

The shocking thing to us is how little this is being talked about in Kansas City. If you are reading this and you know someone who owns a business, please consider forwarding this on to make sure they are in the loop… you never know when they are considering a sale of their business.

There are many sources on the internet documenting the potential rise and we especially liked the article from Forbes discussing how the increase could go based on various legislation. (Source link: Forbes, January 24, 2012)

Too Much Revenue for ONE Customer?

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TooManyEggsThis is another real world story of the interesting situations that we find when brokering deals.

We had a great business with great cash flow and great products. On the surface, everything looked like this was a business that could be sold at 3 or 4 times cash flow. When we dug deeper, we found that there was one huge customer. Yes, the customer was profitable, but they made up two-thirds of the business revenue. That is challenge enough, but it got worse. The account manager for this major customer was a family member of the owner, and was being paid twice the market rate for their position.

The price of a business gets discounted for each of these situations separately, but when combined, it makes it almost impossible to get a deal done. In this situation, the person that would benefit the most and have the best chance for success, as a buyer, is the family member. But they are also the individual with the most leverage to influence business price.

What could the business owner have done to have a better chance at selling? The business owner needed to be making strategic changes at least 12 months before trying to sell. The first move would be to get a new account manager involved with the major customer to minimize the risk of the relationship with the family member. In addition, it would be a good idea to have an employment agreement in place with the new account manager that includes a non-compete. The harder thing is to expand the business so that one customer doesn’t represent so much of the revenue stream. Not easy, but this can be done.

If everything can be fixed except for the customer concentration, you could probably sell, but be prepared to finance the buyer.