As we are now several months into varying levels of COVID-related lock downs, with no discernible end in site, it is becoming clear that businesses need to continue to work on increased effectiveness and productivity with a remote work force. Given that many buyers of businesses that Codiligent represents (as well as some sellers) are located out of the area, Codiligent has been accustomed to working with remote teams for years: it is paperless, uses digital due diligence data rooms, and has always had far more video and teleconferences than in-person meetings due to geographic locations of buyers and sellers. However, there has still been a noticeable shift of in-person meetings (networking, client meetings, etc.) to video, teleconferences, and other forms of digital collaboration. I also recognize that most of the business owners we interact with have had a material shift to remote collaboration with internal staff, customers, vendors, and other external parties. The following Harvard Business Review video provides some tips on how to more effectively collaborate with remote teams.
Even when a business has strong repeat customers, buyers will naturally question if a change in ownership will cause customer attrition. One way to help alleviate a buyer’s customer attrition concern is through the use of customer contracts (if appropriate) that outline the basic terms of the relationship, and if possible, indicates the anticipated sales volume. For many businesses, however, customer contracts would need to allow for fairly easy cancellation in order to get customers to sign them. Also, as with any customer contract, you will want to ensure that your attorney includes language in the contract to allow for the transfer or assignability of the contract to a new owner when you sell your business.
While many businesses see some level of fluctuation in their net margins from year-to-year, in most well-run businesses gross profit margins (Sales less Cost of Goods Sold) will remain consistent or will gradually increase as supplier volume discounts kick-in or better purchasing or efficiency is gained. Fluctuating gross margins can signal a variety of possible problems to a buyer including: 1, the business is subject to fluctuations in inventory and other direct costs of producing its product or service, and the business isn’t able to pass along those price increases to its customers; 2, the business has inconsistent suppliers; 3, the business hasn’t been able to manage wages or production costs efficiently; or 4, the business may be inconsistently reporting expenses where in some years it classifies certain expenses as Cost of Goods Sold and in other years as Sales, General and Administrative expenses.
There are some legitimate reasons why gross margins could significantly vary which may not be due to problems. For example, if a company had a significant shift in sales of products or services that have different levels of Cost of Goods Sold it could be a valid reason for a significant shift in overall gross margin. Yet, even this type of change may lead to buyer uncertainty because they could view the company as being less stable and certain.
If your company’s gross margins are fluctuating from year-to-year it is something you may want to either resolve prior to selling, or have a good explanation for the fluctuations that won’t cause buyers to perceive more risk.
Businesses that offer a more thoughtful user experience are able to not only differentiate in a way that may attract more customers, but also in a way that may make their business more marketable. Think about some of the large businesses where the customer experience is a significant driver of customer-perceived value: Apple, Four Seasons, Starbucks, Nordstrom, etc. One thing that such businesses have in common is strong attention to how physical design contributes to the user experience. During these times of varying degrees of shut down due to the pandemic, it may provide more time to think about how physical design impacts your business' user experience, and how that may, in turn, contribute to your business' marketability and value. Following is a video from Monocle that provides some inspiration based on how other businesses have thought about design.
I'm frequently asked, "what makes a business attractive to prospective buyers?" This can depend on a variety of factors, including the objectives of the buyer and whether they are a financial buyer or a strategic buyer, who will gain additional benefits from an acquisition beyond the stand alone performance of the business. Generally, though, a business will be considered attractive if it has low risk factors, strong financial performance, and good potential for growth.
Some of the specific things that will tend to make a business attractive to buyers include:
If you would like to better understand what issues may be impacting marketability and value of your business, Codiligent business brokers invites you to schedule a Marketability Assessment appointment. This is provided as a free service to businesses that have been in operation for at least three full years and that have a minimum of $2 million in annual revenue.
You've worked hard to build a successful business and now you are selling and in discussions with a buyer. If you are like many business owners you are proud of what you have accomplished but also recognize how much work it required to build your business. Along the way you've learned tips and tricks that have helped you to be more efficient and effective in your key management role. Perhaps the buyer has suggested that they would like you to consider staying on as a paid executive for the first 1-2 years after the sale has been completed. If you're like many people in this situation, you may be tempted to convey how important you are to the operation of the business because you'd like the buyer to pay you a good salary for your ongoing transition role in the business. Your inclination may be to say something like, "I've been the key person doing R&D and nobody else in the organization is truly ready to replace me, yet. Because I know the ins and outs of the business if you were to replace me it would likely require 1.5-2 staff members." You may not want to say this.
Don't get me wrong - I'm not suggesting that you lie if this is, in fact, the case. However, if you are like many business owners you are also playing some roles in the company that could be delegated, you likely are spending some of your work week devoted to more personal projects, and there may actually be people with strong experience out there who could be hired who are more efficient and effective than you are. The problem with selling how important you are to the operation of the business is that a business buyer may have second thoughts about whether they can successfully operate the business without you, whether they will they be able to find an eventual replacement for you, and if they will need to significantly increase the budget for replacement staff which increases their projected expenses and thus, lowers profitability and value.
Maybe exaggerating your importance helps you negotiate a higher pay rate for your 1-2 year transition, but what does this mean for the valuation of your business? If the market rate for your position is $150,000, but a buyer believes that they will have to hire two $100,000 employees to replace you, that means they will have $50,000+ in greater expenses and lower profits. That additional $50,000 profit if included in valuation calculations may mean a difference in value of $150,000 - $300,000 in business value.
When a buyer looks at acquiring a business, they will calculate an anticipated rate of return on their investment. When calculating their return, they will look beyond the purchase price of the business and will also take into consideration additional money they will need to invest in working capital, improvements, and capital expenditures. If the anticipated capital expenditures are significant, it may result in a lower value and less marketable company simply because of the impact capital expenditures will have on a buyer’s return on investment.
If your business is in need of significant capital expenditures, should you go ahead and make them before selling? There isn’t an easy answer to this question, and you should always consult your business sale advisors to discuss the specifics of your company’s situation, the type of asset(s) in question, the level of investment, whether financial performance can be maintained without the investment, and the short-term impact on cash flow. If such decisions are made without consulting advisors, a seller may be shocked by the impact on their ability to sell.
While having aging payables may seem like somewhat of a positive as it indicates the ability to conserve cash, payables that are aged beyond 30 days can cause concern for a business buyer. The reasons for this concern include:
Do you prefer securing fewer clients who each generate more revenue, or working with more clients but who in aggregate produce a similar level of revenue? If you are like many small business owners you may perceive this to be a no-brainer, understanding that the fewer clients you work with the less sales, general, and administrative expense you'll likely have - not to mention the hassle and headache of dealing with a broader number of clients.
However, when it comes to selling a business, having higher percentages of revenue coming from fewer clients may negatively impact marketability and value. Business buyers are interested in acquiring companies that have low risk to future cash flow. Generally when a business has more than 7% of its revenue coming from any single client, buyers will begin to be concerned about the financial risk of losing larger clients and this will start to impact price and deal structure.
Following are a few suggestions on ways to prevent this from becoming a marketability issue:
Following are two videos that provide more information about earn-outs.
Buy and Sell Well
Codiligent Business Brokers' blog on entrepreneurship, capitalism, and successfully buying and selling businesses.
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