As we know, there are countless considerations when transferring the ownership of a business. Before any real plans to sell a business can commence, a business owner first must compare the value of their business today with the amount that they want or need their business to be worth when they sell it, because there’s often a gap between those two numbers. One of the quickest ways to close that gap is by enhancing the value of their business. Two strategies we suggest you recommend to your business owner clients are to decrease the risk of the sale and to improve cash flow.
Decrease the Risk of the Sale
Business value can vary based on projected cash flow and the likelihood of achieving that level of cash flow. Buyers are looking for companies with stable and increasing cash flow. If an owner can decrease cash flow volatility in the eyes of the buyer and improve confidence in projected future cash flow, they in turn might increase the value of their business in the eyes of potential buyers. There are several strategies you can suggest to your business owner clients to help them lower their risk profile.
Diversification of a business’s products, customers, and suppliers ensures the loss of any one relationship does not negatively impact business value. If a business owner runs into some type of emergency, such as an order getting lost in transit, an important customer contract falling through, a new competitor entering the market, or a world-wide pandemic impacting transportation and distribution systems, they need to be prepared to pivot. With a vast product line, a variety of different consumers from different areas, and multiple reliable suppliers, common business challenges won’t completely derail their business. A diverse business is better positioned for any unfortunate external challenge. As business owners and advisors know all too well, unfortunate external challenges happen far too often to not plan for them. This effort to reduce risk through diversification improves the ability to predict future cash flow with confidence, potentially increasing the price a buyer will pay to get access to that cash flow.
Another perspective on the ways that we can use cash flow to improve business value is the idea of stabilizing revenue. By stabilizing revenue, it becomes easier to project future cash flow and in turn create more accurate plans for the future. A consistent, reliable history of cash flow typically creates an expectation that the same pattern will continue in the future. This is similar to the reasons why there are much lower rates of return on debt investments like bonds as opposed to equity investments.
When you ride a roller coaster, for example, you expect the entire ride to be full of dramatic ups and downs until you finally open your eyes and the ride comes to a screeching halt. Similar to cash flow, if your client falls in these patterns of drastic highs and lows, their projected cash flow can be volatile resulting the sale of the business to be a bit riskier because buyers will naturally brace themselves for those big changes.
Build the Right Team
One of the main factors that business owners commonly overlook when they begin their ownership transition planning is effectively building and keeping a strong, reliable team they can trust to continue to profitably run their business after they leave. Having a strong management team in place is also one of the main factors buyers look at when contemplating an acquisition of a business.
When an owner takes on too much responsibility, by managing important customer relationships, coordinating with key vendors, and driving all of the future goals and plans, the company is relying too heavily on that owner. So, when the day finally comes that the owner is ready to sell their business, it is worthless without them. Long before an owner is ready to sell, it is critical to take a long, hard look at the responsibilities and tasks at hand that keep their business operating efficiently. For an owner, it is natural to want to do and have control of almost every aspect of the business. But by taking a step back and training people they can trust to take over their responsibilities, they will greatly decrease their risk profile and enhance the value of the business in the long run.
Finding and growing this management team is obviously the first phase but the most important step is figuring out a way to keep this management team in place long after the business owner sells. As a trusted advisor, you can help your client create strong incentive plans for your key employees to motivate them to continue growing the business.
In the end, finding the right people, training them, delegating to them, and incentivizing them to grow the business and stick with it long-term all contribute to cash flow growth and strength, which turn into business value.
Have Efficient Operating Systems in Place
Not only is it important to have a strong suite of offerings and management team to increase business value, but you should also advise your clients to have operating systems in place to successfully continue the business after the ownership transfer. This adds a level a stability and constituency to the business, again lowering the risk of the sale and increasing the value of your client’s business. Strong operating systems can also impact turnover rates, onboarding, overall efficiency, and overall workplace morale. Standardized and documented operating systems improve efficiency and reduce errors and waste, which in turn stabilize and maximize cash flow that attracts top-dollar buyers.
While minimizing risk often has a powerful impact on business value and cash flow, business owners must also keep a close eye on the inflow and outflow of their day-to-day capital. Tune in next week to learn how to enhance business value with responsible utilization of a business’s available cash flow.