According to Factset, 2017 has been a tough year so far for middle-market companies looking to sell. During the last 12 months, middle-market deals have declined about 10% compared to the prior year, with an 11% decrease in the premium paid year-over-year.
When it’s difficult to ask for top dollar for your business, differentiate yourself by doing your homework first before talking to potential buyers. Below are five key areas business owners often neglect to consider when preparing their business for sale.
Are your products/services diversified?
Product and service diversification in this case means more than market segment or type of products/services; it refers to how dependent your products/services are on various market conditions. It is not uncommon for a business to think its product lineup is diversified, only to find out during a market downturn that all sales are reliant on one or two critical factors. Ask yourself the following questions to see if you’re properly diversified:
- Do all sales depend on the same set of factors?
- Is my cost of goods sold determined by a select few critical components?
- Do I rely on a handful of vendors to create my products?
- Am I dependent on certain credit conditions to profitably make my products?
If you answered yes to any of these questions, begin exploring new ways to update your offerings to introduce more diversification – and thus help protect your cash flow from market changes. Explore alternative ways to finance production and sales of your product/service. Find new vendors that can give you more pricing power with your current vendors. Re-assess your willingness to use mostly cash or credit to fund production costs. Diversification doesn’t have to mean a new offering or market segment; it can mean finding ways to make your revenue stream more reliable by being less dependent on any single factor.
Are your products/services protected?
A buyer is likely to pay a higher multiple for your business if the projected cash flow is higher. One way to help ensure higher future cash flows is by offering products and services protected from competition. Does your company have patents, copyrights, trademarks, proprietary technology or expertise that give the company a sustainable competitive advantage? If not, determine whether your current offerings could be protected through one of these methods, and consider investing in new projects that could result in a protected offering. Begin thinking about how to make your business more immune to competitors before you actively look to sell.
Diversified customer portfolio
In addition to reviewing your products and services, it’s important to assess the diversity of your customer base. Consider the following questions:
- What percent of sales is attributed to your top 5 customers?
- What percent of your customers have been buying from you for more than 5 years?
- What distribution channels are your customers using to make purchases?
By looking at the percent of sales to your top customers, a buyer can quickly determine whether your company’s success hinges on a select few customers. The broader your customer base, the less risk posed to a buyer, and the higher the multiple you can ask for.
Likewise, a buyer can get another view of your business’ risk by looking at customer loyalty. A customer portfolio with a lot of turnover and very few long-term clients may highlight a competitive marketplace and make it difficult to ensure future profitability. Conversely, a lack of new customers could also draw a potential buyer’s attention. If either is the case, be prepared to explain why. A buyer could perceive few new customers as a signal that your company isn’t growing, or too many new customers as a lack of loyalty to your business.
How your customer purchases your offerings could also influence a buyer’s perception of risk. The brick-and-mortar retail industry is a prime example of what could happen if you rely too heavily on one distribution method. Take a hard look at your business and determine if there are ways to grow sales through other distribution methods. Doing so may open up new sales opportunities that can boost the value of your business.
Personnel’s influence on value
One of your most important assets is often your leadership and staff. Most buyers would be reluctant to enter into a deal if they believe key personnel may be ready to jump ship. Some questions to consider include:
- Does the company rely on a few integral managers to conduct business?
- Are succession plans in place for critical leadership positions?
- What is the employee relations environment? Are labor unions involved?
Most buyers will expect the company to rely on key leaders to keep the operations running. Where most sellers fall short is having a plan in place for those key leaders upon sale. For example, a buyer may find the deal less risky if key managers are under contract to remain in the business – and, even better, if they’ve signed a non-compete clause. Implementing a long-term succession plan for critical roles, not simply the particular people in those roles, can reduce a buyer’s perception of risk and result in a higher purchasing price multiple.
In addition to management stability, be prepared to explain what the culture and relationships are like with entry and mid-level staff. The business cannot run without these people, and buyers need to know whether there will likely be a smooth transition. Your relationship with front-line staff influences how smooth an ownership transition might be. Be prepared to explain to the buyer what (if any) information about potential business transition has been communicated, how staff members have received this information, and the potential level of acceptance or concern throughout the company. A buyer will be less likely to pay a premium for a business in which he/she is unsure how productive the staff will be after the transfer.
Future trends & expectations
Be prepared to explain the industry trends, challenges and opportunities that may not be obvious to a buyer not already involved in your industry. Additionally, you’ll want to outline any major initiatives you have in mind for the company. Do you have plans for major capital expenditures? How will they be financed? Are they full-blown replacements, or just significant upgrades to current equipment? Are there pending liabilities or benefits not yet reflected in the books? The answers may not influence a buyer’s decision to buy, but being prepared with well-thought-out answers can.