Business entrepreneurs must always be ready for that fateful moment when a once-in-a-lifetime business opportunity comes around. All too often, business owners do not have their financial house in order and cannot close the deal.
In the course of 15-plus years leading a team at CompBenefits Corp., which built a business to over $360 million of revenue, we did six acquisitions, including a $100 million Miami-based company, and talked to 15 to 20 companies for every one we bought. We bypassed many promising companies because they could not quantify/validate their business success or their operational model. What we learned: If you are not ready for a transaction, an important opportunity may pass you by. The same concerns are applicable to those seeking to purchase another company when a special opportunity arrives — as such an opportunity will likely require validation of your business position to a bank or a private equity investor. It’s an important issue in South Florida, with its significant number of small or medium-sized family businesses. These firms often find themselves contemplating a sale, particularly in second and third generations.
So, what is the best way to get your company ready? Here are five key fundamentals to help business owners get ready for selling or buying a business.
1. Determine your personal and corporate objectives. Timing is obviously a function of your needs and objectives. Business owners and executives explore their options for a variety of personal reasons that can be individual (i.e. boredom/burnout, age, health, tolerance for risk, loss of entrepreneurial spirit, etc.) or economical (i.e. growing macro-economic risks, lack of capital, sea changes in your industry, desire to achieve liquidity). It is critical to know and understand your personal and business objectives in order for you to plan ahead and be ready to act.
2. Determine time frames and prepare written growth and exit plan strategies. Deals can be structured to yield multiple possibilities — e.g. a total sale or a minority recap where you or your team stay in charge. The importance of having an exit strategy is to help you determine the strategic direction for your company. Having a plan protects the value of your business, creates a smooth transition (whether you are selling or passing the firm to other team members) and reduces or defers potential tax implications. So don’t limit your future options. Have a plan in place.
3. Build your “story.” Identify, improve, protect, document/quantify, and communicate the drivers of your business. Too often, the business owner has strong beliefs about the strengths of the business — but has failed to specifically build the evidence of these positive traits. For example, you are certain you have an exceptional operations team, leading to materially better profit margins which will be gained by the acquiring firm. However, can you provide quantified evidence of this assertion? A buyer will want to see detailed operational data over several years (hopefully broken down by quarterly results). If the data are not available, this positive operational advantage will be difficult to value — as the buyer will see risk. And the higher the risk associated with a transaction, the lower the price. High quality monthly/quarterly data over several years (to allow analysis of trends) is essential to reducing the perceived risk factors of the business.
4. Get your corporate financial house in order. Have reviewed or audited financials — a very positive step toward providing independent validation of the consistency of your records — another risk-reducing factor. Create monthly or quarterly financials — done within a consistent accounting format. It is important to have three to five years of reliable reported financial history. In addition, have a detailed budget for the current year and a pro forma projecting the next two to three years — with a list of all key assumptions made in the projections. Track and act on key performance and operational metrics. Integrate sales reports/pipelines into your financial systems. It is important to work with experienced financial professionals that can help you with all the financial aspects of your business — to assist you in validating your results.
5. Obtain independent/objective assessment of the value of your firm, your readiness for market transactions and areas you can improve to maximize valuation. Do not rely on simple formulas or industry “rules of thumb” to value your company. There are numerous methods of valuation focusing on cash flows, assets, comparable sales, capitalization of income stream, replacement cost, price/earnings ratio, book value, etc. However, certain approaches work best for different middle market businesses, so don’t rely on one approach to calculate your valuation. Your goal is to obtain premium value. Most of us are amateurs when it comes to selling or buying a business. Seek respected and independent outside experts to assist you in focusing on your key drivers of value.
David Klock, Ph.D, is dean of the College of Business at Florida International University and former chairman and CEO of CompBenefits.