Cash Flow is KING:    Cash In - Cash Out = Cash Flow

1. Organized Record Keeping (we harp on this topic in other posts) 
2. Collect Money and Fees Upfront
3. Collect Accounts Receivable
4. Audit All Expenses Yearly
5. Extend Supplier & Vendor Debts
6. Examine Employees & Make Personal Cutbacks
7. Review Capital Assets
8. Decrease Non-necessary Spending
9. Inventory Management & Transportation Costs

Every good business owner knows that cash flow is the life blood to their company’s existence.  When positioning a company for sale, positive cash flow is critical in determining a company’s fair market value.  For specific breakdowns of each area listed above, please click the link provided above. 

Know your value.  Know your business.
 

•  Maintain clean financial books and records
  • Keeping business and personal expenses separate is ideal.  For many small business owners, they treat the company’s cash flow like a personal checking account.  Often times family expenses beyond owner compensation are being paid by the business such as meals, vacations, automobile, gas, insurance, phones, etc.  When preparing a business to sell, not only would these “owner benefits” be reflected back into the company’s earnings, but it will also have to be explained to a potentially skeptical buyer.  Keeping these types of expenses separate is of value when owners want to avoid buyer skepticism.
  • Studies from major accounting firms and even our own experiences have indicated that companies with audited financials, or at least professionally managed books for small businesses, will consistently fetch a higher purchase price than those not well kept.  If it’s not documented, it’s not accounted for.
• Achieve for positive trending
  • Typically, the most recent 3-5 years of performance and 2-3 projections will be the closest examined periods in determining a company’s value.  Showing positive trends and growth in both revenues, net income and “owner’s discretionary earnings” will have a significant impact on value.  When businesses suffer due to factors out of their control (industry dips, seasonal declines, etc) those can more easily be accounted for.  When the business declines due to lack of performance on its own accord in comparison to similar companies in a similar industry, this will certainly drop a company’s fair market value and strategic value.
  • Buyer’s are purchasing future cash flows and potential.  If you’re in a decline, why would a buyer pay a premium?  Many business owners, rightfully so, believe their company is worth much more than it is due to the time, sweat, and effort invested into their business.  Owners who can step away from the situation and evaluate their business from a buyer’s perspective will appreciate the fact that positively trending cash flow and a positive outlook into the future will make the company that much more attractive and valuable.
• Profitable process chain
  • With today’s advances in technology and automation, a company’s systems and process chain requires evolution.  Business owners who accept change and readily adapt to more efficient and productive ways to operate their business will not only increase profits, but also building a system that can sustain additional growth will less operational costs required.  Such automation or process changes can greatly impact value as the future operational and profit prospects of the business or ideal.
  • If your company is involved in the production of a product or service, you should evaluate your company’s core strengths and weaknesses.  Many owner’s in today’s world are outsourcing elements of their process chain.  While letting go control of certain aspects of your business can prove daunting, owners who find strategic partners to produce or manufacture key processes in their business can become much more efficient, increase quality, profitability and customer satisfaction.  Identify opportunities and seek out expert partners who you can strategically outsource to.
• Make the business less reliant on you
  • If you wanted to, could you take off on vacation of the next 2-3 weeks (minimum) and your company not skip a beat?  If not, strive for this goal.  When a company is heavily reliant on an owner who works “in” the business, it is more susceptible to a lower valuation.  This is certainly true for companies with less than 10 employees where often times the owner is the business.  In his or her absence, clients will leave and the company’s ability to function is all but paralyzed.  Owner’s who can develop sound processes, responsible management, and a value chain to serve clients will be able to step away from working “in” the business and work “on” the business.
  • When a small business owner sells, the buyer will typically step in to run the company, as opposed to hiring a manager to run it for them.  It is important that a current owner lay the foundation for a completely new individual to seamlessly walk into the business and have the ability to successfully run it within 3-6 months time.  Making it as easy on a buyer to take over management is key in maintain and creating value in your business.

There are certainly many other major factors that will influence the value of a business (goodwill, client acquisition efficiencies, competitive landscape, fixed assets, inventory etc), but some of the above examples you can address sooner rather than later for a positive business valuation.  Know your value, Know your business.  If you have any other tips or advice, please leave a comment.

Statistic:  “”It is estimated that less than 15% of business owners have developed an exit plan from their business, despite the reality that it is a certain outcome for every business owner.”" 

Only 15%??  This is an alarming number, especially for baby boomer business owners.  The first step in this process is having an idea of what the business is worth through a business valuation.  Otherwise, the business owner is operating blindly due to the common errors and wrong assumptions in an owner-driven valuation.

 If you own a stable and growing business, with predictable revenue and discretionary cash flow, you have a QUALITY business.  Size and industry will greatly drive the supply and demand of sellers and buyers, but during this economic down turn, it’s critical to protect the value you’ve established!  Don’t sit idle in a down market as this could greatly hurt your company’s valuation.  Owners who plan today, can execute tomorrow with success and precision.

One specific area we want to highlight is the requirement of an independent, third party business valuation for SBA loans exceeding $350,000.  Here is the exert:

(i) Business Valuation

(a) Determining the value of a business is the key component to the analysis of any loan application for a change of ownership. The need for an accurate valuation is true regardless of whether the financing is structured as an asset purchase or a business purchase.

1. For loans less than $350,000, a lender may do its own valuation of the business begin sold to identify whether the seller is requiring a price that is not supported by the business’s historical performance.

2. For loans of $350,000 or more, the lender must obtain an independent business valuation from a qualified source.

As this emphasizes business valuation for a “change in ownership”, in many cases, a business valuation has already been conducted by the seller, assuming they are working with a legitimate intermediary/broker.  Some business brokers will conduct an analysis themselves, while others will assist in the gather and recasting of data, then bringing in a legitimate, third-party valuation firm for modelling, analysis and reporting. 

If an independent business valuation has not been performed, then banks need to seek a qualified source for valuation work.  A great example which validates such ’Checks & Balances’ can be found in the following audit report conducted by the SBA where a lender provided a valuation, but it was tainted due to biased opinions and the subject company grossly overvalued, leading to a loan default.

We have a call into SBA headquarters for more information and will update everyone should any additional findings be of key relevance.

Business valuation indicators are showing strong multiples for technology and software-related companies as well as those that cater to the baby boomer and senior demographics.  For the fifth consecutive year, Inc and Business Valuation Resources (the authority on valuation data, metrics, and comps) have prepared an interactive study to analyze the valuation of middle market companies (those with annual sales from $10 million $500 million).  Take a moment to visit this resource and see how your company stacks up compared to nearly 4,000 mid-market transactions analyzed over a 3-year window.

A word of caution.  While more than 140 industries are analyzed, you may not find an ideal comp for your business.  There is a big difference between a strategic buyer and a financial buyer.  Small businesses with sales of less than $10 million need to be aware that rule of thumb multiples based on adjusted EBITDA are typically less than middle market.  Per Rob Slee’s excellent book “Midas Managers”, firms considered small business generally see 2-4X adjusted EBITDA while those with sales in from $10MM to $100MM are more likely to see 5-7X.  Using a generic multiple is very dangerous for any business owner and is not recommended.  Determining your company’s market value through the process of an independent business valuation is THE first step and owner should take prior to taking their company to market.  Let’s take a $1MM annual sales, $200K discretionary cash flow business.  Using a simple 2-4X multiple leaves a gaping margin of error of $400,000!!!  Your business is most likely your most valuable asset.  Don’t fall prey to assumptions and being a penny-wise, pound foolish when it comes to business valuation.  Each buyer is different, with different motives for acquisition (financial, strategic, etc).  A business priced too high will not sale.  A business priced too low, well you know what happens then.

Know your value.  Know your business.

• A business broker can be your best ally in selling a business of that size
• Questions to ask a business broker
• Business broker fee and service expectations

Due to the overwhelming importance of the sale of a small business, conducting an independent business valuation is of utmost important in the first step to selling:  setting the price right.  Most quality brokers should be able to assist you in preparing for a third-party valuation, serving as a conduit.

If you own a business and share that ownership with other partners, it is important that you create measures to protect everyone’s best interests in the form of a buy-sell agreement.  Seek your attorney for such matters so that it is fair, carries goodwill and is responsible to all shareholders within your business.  In the absence of a buy-sell, ownership claims and buyouts are at jeopardy in most cases leading to litigation and exorbitant legal fees with few winners in the end.

Now, this catchy phrase should be at the top of every business owners’ mind (not just start-ups) as we enter what analysts project to be a tumultuous next couple of years.  Rob Slee, investment banking guru, paints a very grim future for today’s business owner based on 10-year, US economic cycles over the past few decades:

• “Owners are currently faced with an adult decision:  to either get strategic about their businesses or to get out as soon as possible.”
• “A further challenge to owners is the uncertain US economy.  Actually the economy tipped to the dark side toward the end of 2007.”
• “…..private equity and hedge funds also have had too much money for their own good.  These classes, which represent trillions of dollars, will be reset over the next 3-4 years, making the sub-prime thing seem like a drop in the bucket.”
• “…..business owners have until the 2^nd quarter of 2008 to sell out, or they will need to hold their companies until 2015 or so before they can maximize a sale.  Yikes!”
• “You still have a few months to sell-out before the nasty economic front settles in.  We’re about to face capitalism at its coldest.”

No one can foretell the future, but Rob Slee uses historical trends of economic trends to validate his points.  With the US still recovering from the sub-prime crisis, being locked in to a nasty war, and trying to determine who will become the next President, business owners are at more risk in possibly declining SMB valuations and opportunities to sell their business.

Our recommendation:  Run from the lion and sell your business (if you’ve been debating this over the past couple of years).

For additional insight and to add to this discussion, please read our article on Baby Boomer Business Owners flooding the marketplace with “for sale” companies.

• 74% recommend a professional business valuation to determine a fair, credible asking price
• 71% recommend hiring a professional (such as a business broker) to coordinate & facilitate the entire selling process

A common sentiment amongst these business owners who decided to manage the entire process independent of outside assistance was “the process was often lonely, emotional and conducted without proper planning”.  Two other key quotes & findings from this study when business owners did it themselves:

1. “Business owners are waiting till they get an offer before they address key issues in selling a business, which means they’re not negotiating from strength, and are leaving money on the table.”
2. “….the former owners regret their failure to get the best deal not just for themselves, but for their management, staff and customers.”

If these trends are important to you and the sale of your business, take time to read the entire article and then strongly consider the involvement of professionals who understand and are experienced in the complexities of business valuation and business transactions. 

V = P x S x E

Valuation = Problem solved x Solution’s elegance x Experience of management

The maximum score for P, S, & E is 3; where the highest score is 27.  The higher the score, the greater odds for start-up success.  If “V” (valuation) is less than 5, it can be assumed the business idea is destined for failure.

If you are a business owner, take a moment to apply this very simplistic yet eye-opening formula to your own business valuation.  On the surface, this is a good exercise for budding entrepreneurs, investors, and/or potential partners.   Give it a try and let us know your thoughts.

Putting this model to the test, we examined our own business, Fair Market Valuations:

P = 3
S = 2.2
E = 2.2

3 (P) x 2.3 (S) x 2.3 (E) = 15.9 (V)

You’ll obviously have a bias towards your own company or business idea, but ask a handful of mentors or trusted advisors to rate your business using this simplistic model; take the average valuation and reflect on your potential.   Good luck and as always — Know your value.  Know your business.