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University of Massachusetts Amherst

Family Business Center

Ensuring higher business valuations:

It's time for small- to mid-sized companies to plan ahead.

By Martin J. Kupferman

If you own a small- to mid-sized business and are considering selling your company, you may find that now is not the right time. Due to declining stock prices and a slower economy, deals at top value are harder to achieve. It is crucial that you move carefully and understand your options thoroughly.

M&A transactions, past and present

In the mid- to late '90s, business mergers and acquisitions (M&A) were strong in terms of both values and transactions. While the big M&A picture remains strong, the market is more erratic, and certainly buyers now have the upper hand. At a minimum, M&A transactions take longer. Also, debt capital is tougher to obtain, and deals are closing nearer to 5x EBITDA than yesterday's more attractive 7x.

While this environment may not weigh on the side of owners of small- to mid-sized businesses selling their companies at present, it is a great time in the business and M&A cycle to position themselves for enhanced value down the line.

Planning is key to higher valuations

As a business owner, you sometimes have to fight to keep your numbers on track. To say you have a lot on your plate is an understatement. But you need to make room for one more item. You need to understand that selling your business is a process, which is best to begin well in advance of the sale due to the structure of the M&A marketplace.

Highest valuations are more likely to come from strategic buyers - generally companies doing business in the same or related industries. Traditionally, these buyers pay more than financial buyers do (which proved to be almost 9 percent higher across all industries in 2000). However, these buyers look at M&A deals differently. For example, they value more than just earnings and cash flow.

The strategic buyer is interested in how a target company operates within its own industry. The company's strategy and vision, brand strength, and the quality and depth of its management team are all scrutinized. These important elements are paramount in the selling process and will be addressed in the offering memorandum. Therefore, it is crucial to address these points well in advance of selling your business.

A rule to remember

There is an important rule for all business owners to remember: Multiples of cash flow or revenues applied to earnings can have more influence over valuation than the earnings themselves. As an owner of a smaller to medium-size business, your understanding of this rule becomes especially relevant. To boost tomorrow's multiples today, you need to take action in the following areas:

  • Focus on your vision and strategy. Now is a good time to revisit your business strategy and strategic plan. Not only will it help you in the period leading up to your company's sale, but it will also let the buyer know that your business is well positioned. A good and well-implemented plan will answer this question: Are you properly structured and positioned correctly for future growth by competing in the right markets with the right products? Even if today's answer is "not really," reworking your strategic direction and focusing on the most promising part of your business will go far to improve your business and provide a buyer with a roadmap to achieving upside in the acquisition.
  • Take a critical look at your company's position in your own market. Part of a good plan means knowing where you stand in the metrics relevant to your industry. Ask yourself these questions: Is your brand being effectively managed? How is your company and its product(s) and service(s) viewed by your customers? What does your competition do differently and is it something you should consider doing? Industry data is often publicly available. You can provide the focused thought about your competitive position, augmented by feedback from your customers, sales force and employees. (If you don't have a process for collecting this feedback, now is a good time to start one.)
  • Companies in high growth mode are often inwardly focused and do not invest the time to evaluate themselves against the competition. Moreover, they don't take a critical look at where their industry is headed. Being well positioned in an industry with good growth prospects will be an important boost to your valuation multiple. It's an impressive thing if you can demonstrate that going into a sale process. If not, it's a good time to consider any meaningful steps you might take in beginning to reposition your company in the period leading up to the sale.
  • Develop a succession plan. Buyers know that owners don't tarry long after they sell. Get your management team in place and educate them on how your business is run. This will give most buyers comfort that your business won't represent a management resource drain for them. For internal senior managers, this often means more than just ensuring they understand your business. (Presumably, they wouldn't be working for you if this were not the case.) It also means objectively assessing their skills as well as their weaknesses and areas for development. Managers who rise from the ranks in an entrepreneurial company have typically not had the benefit of formal assessment, feedback and coaching. An investment in this area stands to improve their performance. Plus, it will send a strong message that you are invested in their development and success. In turn, this will increase the likelihood that they'll remain at their posts through the uncertain times of a change of ownership.

As a result of reducing risk to the buyer, having some depth of management makes it easier for you to obtain a more liquid purchase consideration. Remember, if your presence is not critical to the buyer(s) in making their numbers, they can more easily be convinced to dispense with complicated vesting or performance provisions, which are often the most difficult and stickiest elements in a transaction negotiation.

  • Don't overlook the "soft stuff." It is important that your employees be aligned with your vision and strategy. Do they understand your vision and goals? Does your company culture - the abstract but all too important realm of values, shared beliefs, norms, behaviors - reinforce your ideals?
    The world of mergers and acquisitions is undergoing a subtle shift as the welter of deals completed in the mid '90s gets absorbed and analyzed. It is now apparent that even as deal makers in acquisitive companies have gained more sophistication about their financial modeling, a lot of their acquisitions still haven't worked out. Culture and its incompatibility are commonly cited as the reason, and today's sophisticated buyer is more likely to focus on that.
    Your company will stand out if you are clear about the kind of culture you envision, and whether you have good alignment (i.e., buy-in) on the part of your employees. If not, it's a good time to get a handle on what your culture really is and how you would like to see it change. In a growing business with a significant proportion of new employees, this often gets watered down or lost. Perhaps bridging that gap is as simple as mounting a communications campaign that explains your company's purpose and ideals to your employees. Often, the management of culture is complex. But think of it like this: The relative ability to align your company's culture is one of the few advantages you as the owner of a small- to mid-sized business have over an owner of a larger business.
  • Evaluate your management and financial information systems. Skilled buyers pay a premium for companies that are on top of the real-time numbers of their business. Evaluating your operating systems carefully can mean the difference between making and breaking a deal. This starts with a set of clean financial statements audited by a credible accounting firm. It also means having a budgeting system in place with both credible and achievable targets. You don't want to miss your budgeted numbers as you enter the marketing, due diligence or closing phase of a sale process.
  • Exorcise "skeletons" before they scare away buyers. Are there any disputes about your intellectual property? Problems with your ownership structure? Threatened or pending lawsuits? Such questionable situations must be resolved before they kill the deal! This means tracing in advance the predictable audit trail that buyers will follow as well as reviewing Board Minutes, stock books, litigation history, stock option plans, employee benefit plans, and more.
    You are well advised to think ahead to the period when a sale is about to be consummated. Are there likely to be dissident shareholders who may present problems? Any licenses or real property leases that the business relies upon for which transfer will be an issue? Problems like these almost always arise. However, they'll be fewer in number and more prone to cost-effective solutions by getting to work on them now. You don't want to enter into negotiations with parties whom you have a dispute with and who have the leverage of knowing that your issue with them stands between you and the sale of your company.

Once these issues have been addressed, one last sizeable item should be considered prior to a sale of your business: Look for attractive ways to scale up!

All else being equal, it is a fact that buyers pay more for size. For the same amount of work, a larger acquiree provides a more diversified, less risky revenue stream. If you see any easily digestible acquisitions, attractive partnerships, or license opportunities on the horizon, now is the time to take action. Size does matter. Bigger is indeed better in the complex world of mergers and acquisitions.

In terms of the outcome of a company's sale, two additional key variables are the quality of the process used in the selling effort and the timing of a sale in terms of momentum of the business and the industry to which it belongs. Preparation of your company for sale is your key to better controlling the outcome!

Martin Kupferman helps owners of small- and mid-sized businesses sell their companies through M&A planning and execution services. Contact him at 415.461.2282 or email him at mjkupferman@home.com.

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