business builder accounting
How to maximize
company’s value
to sell one day
by Kathy Klang
“How much is my business worth?” This is a question that is asked regularly by business owners.
While it may seem like a simple question, the answer can be quite difficult to determine. There are many issues that need to be taken into account when valuing a business. Some of these include:
• What is the purpose for the valuation?
• What is the ownership interest being valued?
• What industry is the business in?
• What are the current economic conditions in general and in the industry?
• What type of business entity is being valued?
The answers to these, and many other questions, will determine the methods used to value the business and the assumptions made in completing that value.
There are many reasons for a business to be valued. Among them are estate and gift planning, buy/sell agreements between shareholders, divorce settlements and other litigation, and mergers, sales or acquisitions.
When companies or individuals look at a business to acquire they are looking at the potential return on their investment to determine what they’ll pay. In this scenario, the measure used is cash flow or earnings potential.
There are several drivers in a company that you should consider when trying to build value.
Stabilize your cash flow and earnings. A consistent history of cash flows translates into lower risk to the investor and higher value for the company. The historical financial statements should show stable, consistent growth that is relative to the industry in which you operate.
Acquisitions of long-term assets should be financed with long-term debt, not paid for out of current operating capital. This will even out cash flows in years where it is necessary to upgrade and replace equipment.
Benchmark your business against your industry. Use information available through trade organizations and industry publications to rank yourself against your competition. Look at sales growth, key expense areas, ratios such as debt-to-equity and current ratio, and income statement percentages.
Is your cost of sales as a percent of sales higher or lower than the industry norm? Are your profits higher or lower than the industry norm? Companies that exceed their industry are considered good investment risks and are therefore worth more to a potential buyer.
Time the sale so that you are willing to stick around for the transition. The new owners generally want the benefit of your experience, relationships and knowledge of the industry during a transition period. The seller’s willingness to work with the new owners for a year or two will often increase the value to the buyer.
Make sure you are not burned out at the time of the sale. This type of an arrangement will often include a non-compete agreement in order to protect the buyer.
Consider selling the assets of the business rather than the stock. In today’s litigious society, buyers often do not want to inherit your business’s potential liabilities.
The purchase of the stock of a corporation includes all of the skeletons in the closet. It also generally results in a lower value due to these unknowns. In most cases you will maximize your value by selling the assets of the company.
Keep your accounts receivable current and minimize bad debts. This is an indication that the company is well run and has a good customer base. Having current AR drives up value.
Manage your inventory efficiently. Excess inventory is very expensive in most cases. Carrying costs include interest on debt to finance the inventory, the cost of storage capacity, the cost of personnel to physically manage the inventory and the potential for obsolescence.
Effective inventory management is a balancing act between the costs of carrying inventory and the potential cost of disruption to your customers due to unavailability of product.
Maintain a well-trained, stable and happy work force. The more your people know about the business the more valuable the business will be to a potential buyer. If the core work force does not change in the transition, customers are less likely to look elsewhere for your product or service.
Time equipment and facility acquisitions carefully. Acquisitions of equipment and facilities affect cash flow and thus value. If possible, wait to replace or upgrade equipment if you may sell.
The other side of the coin is that an out-of-date or poorly maintained plant will drive down the value of the business. Again, this must be properly balanced to maximize value.
Have a clearly defined business strategy and goals. If you do not already engage in regular planning and goal-setting for the business, you should. This is an indication of good management and that the business has a defined focus. The use of an outside facilitator for the planning process will often result in new and creative ideas.
A potential buyer will be able to see where you are taking the business and determine if that path fits with their reasons for acquiring it.
The decision to sell your business can be a very emotional one. Knowing that you have operated your business to maximize its value will make it easier.
[contact] Kathy Klang is a certified public accountant and the success management partner with Cummings, Keegan & Co. in St. Louis Park, which helps businesses and individuals with tax, accounting and business management services: 952.345.2500; kjklang@ckco-cpa.com; www.ckco-cpa.com.
