Gary Jones: Value Drivers In The Sale Of A Business

Editor’s note: Gary Jones, Certified Business Intermediary and Merger & Acquisition Master Intermediary, is a principal at Cornerstone Business Advisors, a Little Rock based business transaction advisory firm which assists owners of small to medium-sized businesses in maximizing the value of their businesses by providing comprehensive business disposition, acquisition and exit planning services.

When meeting with a business owner contemplating the future sale of his or her business, often times it is helpful for me to identify the aspects of their business that prospective buyers will most likely find appealing as well as those areas that are in need of improvement. Though each business is different from the next, I have found there are at least nine value drivers common to most any business. In no particular order, they are as follows:

1. A stable, motivated management team in place. Whether the management team consists of a single owner/operator or one that would fill a large conference table, it is critical that a buyer have some assurance the business will successfully continue long after the sale. A talented, properly incentivized management team can provided day-to-day stability to the business while a new owner settles in. According to a recent national survey conducted by The Sellability Score, business owners with some form of a management team in place are approximately 50% more likely to receive an acceptable offer than those who don’t. Even though sole proprietors may still receive competitive offers, many times those offers obligate the owner to a longer transition period than desired due to lack of management depth.

2. Solid, diversified customer base. Customer concentration is a very common obstacle for business owners to overcome. After all, many companies get their start by a handful of customers who are willing to give them a chance. Often times those initial customers continue to be significant over time, even if the company makes concentrated effort to grow its customer base. If a handful of customers represent a majority of the sales, the business owner should expect alternative proposed deal structures from the buyer, such as an earn-out or holdback provision.

3. Recurring revenue from existing customers. If a business has to “start over” with zero sales every year, a prospective buyer will most likely downgrade the quality of annual revenues when valuing the business. All things being equal, a company with recurring revenue is much more appealing and valuable to the market even though sales, gross margins, etc. are the same.

4. Good and improving cash flows. The business must generate enough cash flow for a prospective buyer to pay his salary, retire debt and realize a return on the original investment of purchasing the business. The lower the cash flow, the more difficult for the buyer to ‘justify’ a strong purchase price. A good exercise for the seller is to ask the question, “Would I purchase this business under these terms, for this salary and this return on investment in view of the inherent risk of owning this business?”

5. Realistic growth strategy. A seller’s claim of double-digit sales growth potential must be supported by a plan showing how that growth will be achieved, and more importantly, that the growth will be profitable. If the potential growth rate is significantly greater than previous history, an astute buyer may request that part of the purchase price be tied to achieving that future growth in the form of an earn-out.

6. Clean financial records and effective financial controls. With recent accounting scandals and increased scrutiny of accounting methods, having audited financial statements is welcomed by a prospective buyer. On the contrary, not having audited statements will increase the due diligence time and costs of the buyer. In any case, well organized company records will increase the buyer’s confidence in the numbers.

7. Systems that improve the sustainability of cash flows. If the present owner’s processes are found on yellow legal pads, chalkboards and sticky notes, a potential buyer will discount his valuation, if not walk away. Well-documented, transferrable and electronic processes are important to a buyer’s evaluation of future cash flows.

8. Facility appearance consistent with offering price. This one may be the hardest one for owners to understand and accept. Even if the facilities don’t drive business and produce sales, they do form an impression on prospective buyers – and on prospective customers as well. Poorly maintained facilities can negatively influence a prospective buyer’s perception of value.

9. Reasonable and supportable value of business. In a recent Market Pulse Survey jointly conducted by International Business Brokers Association (IBBA), M&A Source and Pepperdine Private Capital Markets Project, IBBA’s Chairman Steve Wain noted, “The largest mistake sellers make is unrealistic expectations, and that’s typically tied to valuations.” It is important for an experienced business intermediary to help set an owner’s expectations of how his or her business will be valued by the market.