Many business owners are primarily concerned with the day to day functioning of their business, and ensuring it generates sufficient income to cover the operating costs and meet their personal financial needs. This is of course appropriate, but it is also prudent to consider the inherent value that they are building in their business. Whilst they may not have any immediate plans to leave their business, creating sustainable, transferrable value is a long term project – and an effective insurance policy in the event they have to stop running their business earlier than anticipated.
So what are the factors that enhance the value of a small business?
This is often the most significant item when considering the transferrable value of a business. Many small businesses are totally dependent upon the owner, who has exclusive knowledge of critical processes and retains control of all major decisions. There is a saying that an effective manager will work themselves out of a job. This is particularly true for the owner – manager. If the business cannot operate in the absence of the owner, its value to a potential purchaser is very low. The objective should be to move to a situation where the business can continue to perform in the absence of the owner: which requires the establishment of an effective management structure. There is of course a cost consequence associated with the development of the organisation, which must be factored into the growth plan for the business. When successfully implemented, the owner has the freedom to enjoy time away from the business, and concentrate their efforts in work on those aspects or projects that provide the greatest personal satisfaction.
Predictability of income
One of the biggest uncertainties associated with the acquisition of any business is future performance. How reliable are estimates of future income? Continuing, long term contracts or “rental” type income are the most valuable, as they are most predictable. If the business uses this type of model, maximising the number and duration of such contracts will add to the value. In other types of business, being able to demonstrate a consistent, positive trend in income and the accuracy and reliability of forecasting will provide assurance to a potential purchaser, and therefore enhance the price they will consider paying. Ensuring that the business is not heavily dependent upon a limited number of large customers will reduce the potential risk associated with future income.
Accuracy of business information and documentation
Part of any acquisition process will include a due diligence exercise, where the company’s information and documentation will be scrutinised by external professionals. It should be remembered that from the purchaser’s perspective, any difficulties identified could cause them to abandon the proposed purchase or seek to renegotiate the price. It is therefore in the seller’s interest to ensure that all aspects of the business will stand up to rigorous scrutiny. Whilst some problems can be rectified in the preparations for a sale process, others cannot. For example, it is not always possible to obtain cover for a historical gap in evidence of adequate insurance. It is therefore important that on a continuing basis, all information and documentation is prepared and retained such that it can withstand external scrutiny.
Demonstrating the security of any essential business components
Many businesses will be dependent upon some type of limited resource. It may be a particular raw material where quality or quantity are, or can be, limited; the business may be reliant upon the scarce skills and knowledge of particular employees; there may be an item of equipment that would be difficult or costly to replace. No business owner can control external factors, but it is important to be aware of these vulnerabilities and take whatever realistic actions can be taken to limit their potential impact.
There may be other aspects that are particular to individual businesses, but the important point to recognise is that many of these “value enhancing” factors are associated with the day to day operation of the business, rather than a specific exercise to be taken immediately before starting a sale process. There are many examples of business sales that either fail, or result in a value considerably lower than the expectations of the owner because the necessary preparations have not been made, or started at the right time. In those situations where the proceeds of the sale are the owner’s pension fund, the impact on lifestyle can be literally life changing!
Maximise your business value
CMC Partners have extensive experience of working with owners to maximise the value of their business. We have found that it takes a minimum of three years to ensure the average small business is effectively prepared for a sale process. The earlier the preparations start, the more effective the outcome. To arrange a free, informal conversation with David Brassington to consider the implications for your business, call 07837 903180.