by Kurt Litzelfelner, ASA, Rochester Business Journal, May 2010
Owners of privately-held family owned businesses have a variety of options to consider when they are ready to step down from day-to-day management and transfer their businesses. For many, this will be one of the most difficult decisions of their business careers. The process also can be very stressful and emotional. Some will decide to hand down their business to their adult children using some type of estate planning option or gifting program. Others will decide that the sale of their business represents the best choice to liquidate their holdings. Unfortunately, when it comes time to sell their business, many business owners do not have a good sense of what their business is worth. It is not unusual for a business owner to firmly believe that his or her business is worth a lot more that what it would likely transact for in the marketplace. In addition, all too often they have not properly prepared their business to maximize a sale price.
A good first step to knowing where you stand is to have a business valuation performed by a qualified business valuation professional. This process will reveal the various strengths and weaknesses of the business and provide knowledge to help position the company as best as possible when it is time to sell. Ideally, this process should begin well in advance of the time you actually decide to take your company to market, hopefully in the years – not months – leading up to the sale. Through our experiences, we have noticed a pattern of issues facing many family owned businesses that negatively impact their value. As with many other projects in daily life, preparation can be the key to success and help position the company to realize maximum value upon a sale. While certainly not an exhaustive list, the following summarizes several of the common characteristics of family owned companies that, if left unchecked, can lead to lower values being placed on a business.
Lack of Management Depth.
For many family owned businesses, the current owner has maintained tight control over the direction and operations of their company for many years. This type of owner often has filled many roles: CEO, COO, and head salesman, to name a few. However, when ready to sell, a buyer will attribute a significant portion of the business’s value to the owner, not with the business enterprise itself. As a result, it is imperative that business owners build a solid management team to replace themselves as they approach the time to sell. Of course, this will not be accomplished overnight. It must be part of a well thought out plan.
Many times, companies have one or a few customers that represent a very large portion of annual revenues. While these companies may have had a long and profitable history with this customer(s), oftentimes there is still substantial risk associated with such a concentration. While numerous reasons can be given as to why relationships with major customers are solid, bad things can – and do – happen to even the most seemingly secure customers.
Lack of Growth Strategy.
A major contributor to a business’s value is the potential for growth. The fundamental premise of business valuation is that a company’s value at any given time is the present value of its future economic income stream (most often cash flows). As a result, what the company has done in the past in not necessarily relevant in determining a current value for your company. A business with credible growth opportunities and a plan to achieve these goals will always be more attractive to a buyer than a business that is stagnant. Unfortunately, after initial successes, many small businesses owners become satisfied with maintaining the status quo. Developing a written strategic or business plan and regularly updating it can be one way to keep a focus on developing new strategies for growth. This process may take some time and cost you money, but the effort should help bring a higher value at the time of sale.
Failure to Invest in New or Updated Technologies (or Deferred Maintenance).
In order to continue growing and keeping up with customer demands, most businesses will need to continue to invest in new technologies and equipment. Some business owners take the position that they don’t want to invest in expensive new machinery if their company is going to be sold anyway. However, the flip side to this argument is that investing in new equipment with the latest capabilities may enable greater manufacturing efficiencies (lowering long-term costs) and win new business, thus ultimately creating value for the business today.
Poor Financial Information Systems.
All too often, small businesses lack the financial information systems that many buyers have in their own businesses. In many cases, small privately-owned businesses are not required to have their financial statements audited by an outside certified public accounting firm. However, it might be a good idea to begin obtaining audits during the time leading up to the decision to put your business on the market. Without the strong oversight of an outside accounting firm, faulty accounting practices could result in giving misleading financial information to a potential buyer. Needless to say, buyers commonly revise their offers downwards or rescind them altogether when this occurs.
As previously stated, this is hardly an exhaustive list of potential issues affecting a business’ value, but it does represent some of the common valuation issues witnessed at most companies. Some of these issues may sound familiar to business owners. While addressing these issues is easier said than done, steps taken now to correct or mitigate these risks can improve the chances of obtaining a higher price when you are ready to sell your business.
Kurt J. Litzelfelner, ASA is a Manager at StoneBridge Business Partners. Article reprinted with permission from The Rochester Business Journal.