Addressing Valuation Deficiencies

Over the last five years, our firm has published a series of “Value Advisors” which details valuation ranges for businesses in over 30 industry segments and describes how these ranges vary by how well a business measures up against six internal and external factors.  These six factors are the strength and depth of management, the quality of financial controls, the end markets in which the business operates, the depth and quality of customer base, the competitive threats, and the vendor or supplier risks.  We often preach to owners that if they want to optimize their valuation, they need to address deficiencies in each of these areas.  As a practical matter, addressing all of the problems may take years and if an owner wishes to retire sooner than later then it may be better to focus on those that are relatively easy to change and will yield a good bang for the investment buck.  Our experience has shown that two areas where this is the case are a firm’s financial reporting and management team.

Clean well organized financial information goes a long way to giving buyers more confidence in knowing what they are acquiring.  More specifically, you should re-program the reporting so that it does the following;

  1. Characterize Revenue – If your firm manufactures a variety of products or provides a variety of services of both, then characterize all of this revenue. Break out the reporting so that it shows the revenues for each service and product.
  2. Get more granular on Cost of Goods (COG) – COG is often the best indicator of a product’s or service’s profitability. Buyers are keenly interested in the consistency of margins on a year to year basis.  If your firm has more multiple sources of revenues, then defining the COG for each product or service gives the buyer some very valuable information.
  3. Clean up the balance sheet – Most owners pay little attention to what is reported on their balance sheets.  Updating the status of shareholder loans, long term debt, pre-paid expenses and customer deposits to name a few ledger items gives buyers a more realistic view of the business.  It also demonstrates that you’re on top of the reporting.
  4. Get a handle on Working Capital Requirements – For a business of any significant size, it is important to demonstrate what the businesse’s networking capital is at any given time.  Since it is often included in the offer price being able to know what it will be at the time of sale will be important.  Demonstrating this to a buyer with monthly balance sheets over a two year period gives them an understanding of what to expect.
  5. Report the financials on an Accrual Basis – Cash accounting doesn’t give an accurate picture of all the financial metric of the business. Accrual accounting does.

Having a good management team gives the buyer confidence that the business will outlast the departure of the owner.   Aside from a good operations person, probably the most important hire is the person who will be the interface with clients.  The more an owner can back away from this,  the greater likelihood buyers will pay more and pay more up-front.  One or two key hires can go a long way toward making the business more valuable.

If you don’t have the time horizon to solve everything then just solve a couple of things.  Good financial reporting and a couple of key hires will be a worthwhile investment and will result in a greater return in a sale.

2019-01-23T05:59:11+00:00