February 22, 2022
In our Houston-based M&A valuation practice, we have the privilege of looking under the hood of a lot of businesses. Each business - even within the same industry - is unique. Discovering what makes it tick is something we really enjoy.
This month I want to discuss a few of the value detractors we frequently see in our practice. As you read below, keep a mental scorecard regarding how many enhancers vs. detractors are present in your organization. If you read until the end, you will understand why I say this.
While not an exhaustive list, there are often one or more of these characteristics present in companies in the lower middle market. Left unmanaged, these tendencies of privately-held and family-owned businesses can erode the transferable value of the business.
Value detracting business characteristics:
A certain level of imperfection is expected for a company in the acquisition process. All other factors remaining constant, it gives the buyer something to focus on if they can fix some items and provide immediate improvement. However, it is true that the level of preparation a seller goes through before a sale is directly correlated to the enterprise value and deal-terms received in the sale. These are 5 common value detractors we see:
1. Poor accounting practices and financial record keeping – Most business owners are confident they have a good handle on their accounting systems and treasury management - and for day-to-day cash management and decision-making purposes they usually do. However, selling a middle-market business is stepping into the big leagues, and the buyer of your business will likely be financially savvy. They also have lenders and equity stakeholders who will run complex accounting scenarios and stress tests to evaluate risk, rate of return, and whether other investment opportunities provide safer bets than putting capital to work through the purchase of your business. When faced with the complexity of these accounting professionals and their processes, the typical bookkeeping operation of a privately-held or family-owned business quickly concede that expert assistance is needed.
2. Customer, supplier, vendor concentration – In every area of life, depending on a single variable for a sustained outcome is risky. When you move to sell your business, the continuity of that business is a major point of emphasis. Cross-training employees to perform key functions, having non-compete and employment agreements in place, and occasionally using backup vendors to maintain relationships and test quality or timeliness are all ways to reduce concentration risk in your business. When a change of control takes place, it’s vital that none of the front line workers, vendors, or customers faulter. But if they do, showing you’re prepared with proven, tested backups is the sign of great management and vision. It’s important to create a variety of sources for income, products, and representation to assure a buyer and their capital providers that the investment is well-hedged.
3. Weak, aging, or underdeveloped management teams – The saying “you’re only as strong as your weakest link” is not metaphorical. A strong management team is vital for an organization to function seamlessly. It’s critical to have a management team that is well-trained, a succession plan in place for key positions, and a continuing education process for all managers’ personal and professional growth. A young or inexperienced management team, key positions held by family members, and/or an aging management team all introduce risk (albeit in different ways) to the success of the transition. A well-honed, seasoned, proven management team that will remain with the business after you leave is the preferred scenario.
4. Bygone business model, service, products – Think about how your dentist has automated their scheduling. Do you still require customers to call to make an appointment instead of proactively reminding them it’s time to schedule? Is your website lackluster and over 5 years old? Do your customers often request products or services you could offer but just haven’t? Perhaps it’s time to revisit what your customers are asking for and what you can deliver. Low-energy businesses trade for low valuations. High-energy, focused businesses with a proven culture for measuring, improving, and reinventing often trade at a premium.
5. Tired culture lacking clear processes, procedures, and accountability –A value killer that is often hard for owners to admit is the health of the company culture. If processes and procedures are not clear, employees make up their own workarounds. Such a lack of structure leads to reactionary management and potentially to despondency. It may even stifle ingenuity, causing general sluggishness in the workforce. If you find yourself frequently putting out fires, putting out the same fires over and over, dealing with absenteeism in the ranks, or facing high attrition, then your organization needs to establish clear processes and procedures along with proper accountability when expectations are not met. Many buyers don’t want the job of overhauling a company’s culture, and they’ll pay up for a well-oiled machine with predictable outcomes stemming from proven processes.
Are any of these present in your organization? Viewed from another vantage point, remediating any of these value “detractors” has the potential to convert a weakness to a strength and therefore will likely turn into a value “enhancer.” However, we find the best business sales benefit from having a fixable value detractor or two. At GaP, we are adept at positioning them as opportunities for the buyer to make improvements, and we purposefully seek buyers who are strong in the area(s) where our clients have challenges (and vice versa) so that the union of the two businesses can equal something greater.
If you’re considering selling your business, you may want to read Preparing Your Business for Sale | GaP Advisors (gap-advisors.com) for more tips on getting your business ready.