Growing a Business to Sell
Q: I am in the process of considering different growth opportunities for my manufacturing business. However, I am planning to sell in the next five to 10 years and want to make sure I make the right decisions to make my business more attractive and valuable to a buyer. What are some of the things I should think about as I look at my growth options?
A: Evaluating your growth strategy from the perspective of a buyer/investor is an excellent way to maximize company value. Following is a list of several common areas of focus for buyers, which should help you in your efforts.
A company with a strong focus around a core business generally tends to be more appealing to a buyer than a company going many different directions. First, define your "core competency"-what business are you really in? Make sure that the focus of all members of the management team is aligned in this direction. Are key resources and the various products and services of your firm adding to the value of your core business? Non-core businesses can diminish the profitability of the primary business and decrease the overall value of the company.
Many small businesses can't help but have a handful of customers who generate a large percentage of the company's revenues. In general, a buyer will carefully review any client relationship that comprises more than 10 percent of revenues. Any efforts to reduce the level of customer concentration prior to a sale will be helpful in increasing the reliability of the firm's future revenue stream and will help to increase the firm's value.
On the same note, some companies cater to a particular industry. While this specialization can give them a competitive advantage in winning contracts through industry expertise, it can also force companies to take on risk due to lack of industry diversity. If an industry suffers a cyclical downturn, a company that has the preponderance of its customer base within that industry may be affected as well.
There are times, however, when specialization may result in a premium value. An acquirer operating within the same industry with complementary products or services or who is seeking to enter that market may place a higher value on the company's market position. More commonly, however, industry concentration is viewed as undesirable.
Many privately held companies conduct business on an informal, or "handshake," basis. In fact, many business owners pride themselves on the strength of their word. Informal agreements, however-particularly when they are key to the company's success-can result in a discount to value. Formal agreements can ensure the continuity of key relationships, giving a buyer peace of mind that the company's customer and supplier relationships (and therefore cash flow) are secure. It's best to seek legal advice when establishing these agreements to address issues such as contract transferability and termination clauses.
To the extent that a company or the industry is dependent on geographic exposure and proximity to customers, a long-term lease is more valuable. Again, a buyer expects to attain a certain level of performance. If the company's location is key to performance, a long-term lease not only offers predictable rental expenses, but also ensures that the specific location is locked in for the long term.
Shorter-term leases are more attractive to buyers in situations where the acquirer is seeking relocatable businesses to "tuck in" to their current operations or the current facilities are not large enough to accommodate the company's planned growth. In these scenarios, a company's long-term lease may result in a value discount.
It is common to find that the owners of privately held businesses are involved in almost every aspect of the daily operations. If the owner plans to exit the company, this autocratic structure may become a problem. Efforts should be made to gradually delegate key responsibilities (primarily those related to customer relationships and other direct ties to revenue generation) to various members of the senior management team. A buyer's primary concern is that the business can operate successfully in the absence of the current shareholder.
Loraine MacDonald is director of advisory services at USBX, an investment banking firm specializing in the mergers and acquisitions of small to midsized businesses. She has been involved in the valuation and sale of privately-held businesses for over ten years.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.