Jeff: They say the best things in life are free. So if you're interested in 10 free tips to help you increase the value of your business from a highly successful certified business appraiser, you've come to the right place.
From our studio in Southern California, with guest experts from across the country and around the world this is "Deal Talk," brought to you by Morgan & Westfield, nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.
Jeff: Hello, and welcome back to the web's number one content source for small business owners committed to building a business for eventual sale. Here on "Deal Talk" it's our mission to provide information and guidance from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.
Whether you have recently had your business appraised or not, you've picked a great show to listen to, because if you're like most of us, you want to know concrete ideas that would help you to lift the value of your business. On this edition of "Deal Talk" we have not one, not two, but 10 ways to increase the value of your company. And to explain what these ideas are, I'm joined by the certified business appraiser who put this list together, Ms. Anja Bernier, the managing director of Efficient Evolutions LLC in Boston. Anja Bernier, welcome to "Deal Talk," good to have you.
Anja: Thank you very much.
The idea here truly is that you try to build a customer base that's not specific to a particular industry, so that you have more of a cushion to any events that hit particular industries very hard.
Jeff: You have written a document here called “10 Ways to Increase the Value of Your Company.” And I would like to go over that with you today and give our listeners a chance to understand what it is that they can do or what they need to be thinking about. Let's go ahead and we'll take these one by one if we could.
Jeff: Item number one in your list, increase customer diversification. Now, if I'm a business owner and I've had my business for many years, I may be happy with my customer base or kind of what I'm doing, but why is that important?
Anja: Customer diversification is really one of the factors that play a crucial role in the value of a business. And also when it comes to the perspective of a buyer on what the perspective is on how much risk is involved in buying your company. And obviously risk is a major factor in any valuation. The reason for that is that a high customer concentration typically obviously means that your business is entirely dependent on certain contracts. So as a buyer and an appraiser will have the same perspective, the question always is what happens if this contract goes away?
And you have to keep in mind that as a buyer the perspective or the suspicion, I should say, will always be that a lot of these contracts that are focused on just one customer entail a very close personal relationship between this customer and you. And since you as part of the exit planning will be leaving the company, a potential buyer would be very concerned that that specific customer will leave because you are leaving, because they're really with you because of you. So that is the major factor, a major issue.
And the idea here is that the more customers you have the less likely it is that they're all going to leave at the same time. Think about it, what are the chances if you have 50 or 100 different customers that they all decide within the first 12 months of the acquisition to leave? However, if your business really mostly consists of two, three customers, chances of one or two of them making that decision, therefore in a sense ruining the business, are quite high, so that would significantly decrease the value of your company.
Jeff: I think it's a very, very important point to make, and one too that it goes beyond making every effort possible to keep your happy, satisfied customers, long-term customers with you, keep them in the fold. But you talk about increasing the diversification. Can you give us an example maybe to crystallize more the idea of diversified customers, what it exactly means as far as diversifying? We're talking about obtaining new customers through different industries or product offerings that you might have. Is this talking about maybe trying to work sales channels by increasing your customers maybe in a certain part of the country, for example?
Anja: Yeah, sure. The answer here really is all of the above. I use the example of 9/11 and what happened to companies that primarily sold to the airline industry. If you were a business at that time that was entirely focused on that industry, with the airline industry going into a tailspin after 9/11 you really had no option. A lot of them went out of business. So the idea here truly is that you try to build a customer base that's not specific to a particular industry so that you have more of a cushion to any events that hit particular industries very hard.
The other ideas, today, it's a global world and few recessions hit worldwide with the same intensity. Sometimes it's even possible America might be in a recession and Europe might not be. Oftentimes, obviously, they coincide, but the severity is not necessarily the same. So there's another thing, if you have a product or service that can be sold worldwide it certainly would be a good idea to be looking at worldwide diversification.
And also, coming back to having high customer concentration, were the slow ones. Obviously some businesses will find themselves in this situation where that sort of just, it is the way it is. That is their business and it's very hard for them to change that with short notice.
That said, if you are in a situation where you do have high customer concentration, what you should try to do that you mitigate the risks associated with that, but at least tying these people to you either contractually or by certain services. I had a customer a few years ago, it was a printing company. And what they would do, they were offering their customers free printing plates in exchange for the customers to agreeing to a multi-year contract. Without that offer they would not have agreed to that. But by having them locked in into a multi-year contract that made them more attractive in a sales situation.
Or another customer developed an inventory management software that they sold to their clients at a very low price, essentially at break even. And just to make sure that by using this software the customer became more tied to them and make it more difficult for them to leave, because they would lose access to the inventory management software. And I should add, inventory management software was not the main business that this customer had. They just developed this as a tool to tie people to them.
So there are many ideas out there that you can implement. You have to think about what industry are you in, what can you offer to your customers to entice them to either sign a multi-year contract with you, and or to tie them to you by other means with the example of the inventory management software. They simply can't leave because they really need access to that inventory software program.
Jeff: So really talking about value added services there to help in retaining those customers. We're talking about the 10 things that you can do, 10 ways to increase the value of your company as you are preparing to sell it, whether that be three years, five years down the line, whatever the case may be. And Anja Bernier is our guest today here on "Deal Talk." Number two, develop recurring revenue streams.
Anja: Sure. That's a perfect example. Buyers love recurring revenue streams. And when it comes to valuation, I can tell you an appraiser will put higher value on a recurring revenue stream typically than on non-recurring. Non-recurring meaning it's the type of revenue stream, it's generally one. And each year you sort of have to go out and win new customers again. Recurring revenue stream really means that you have an existing customer base that you can count on.
Giving you an example. Hewlett-Packard sells you that printer for next to nothing, but by doing that they sort of know you're locked in and buying their ink. And where they're really making their money is the ink. So by knowing how many printers they've sold there's sort of a recurring revenue stream coming from the ink. Same is true with Gillette, with razor blades. Given the certain amount of razors being out there in the world, there's an expected revenue stream from the blades.
For example, I had a client a few years ago in the home automation field. And at some point the owner of that company realized that it made more sense for him to install alarm systems at below or break even pricing, because that would allow him to then sign them up for alarm monitoring subscriptions. And that said, if you could think about it, installing an alarm system is a one-time thing when a house is built, and then there's no more revenue from it. It's a perfect example of having to go out again and find a new customer once you finished the installation.
However, getting a subscription to allow monitoring means you have a recurring revenue stream. Every month you can build these customers. And in this case he was even able to then turn around and sell these contracts to some of the large national alarm monitoring companies who pay a lot of money for buying up these kind of contracts. That definitely increases the value of your company significantly if you can think of ways of creating recurring revenue stream.
For example, if you have more on the manufacturing field, think about, for example, adding maintenance service plans to your portfolio. A good example is I recently bought a new QuickBooks subscription and they make you sign up for signing where you get support every month so they can bill you. Or maybe it's not QuickBooks. There are many examples like that where you can think of something where you really get access to a revenue stream that comes every month instead of just being a one-time deal. Buyers love that.
Jeff: That'll take us to number three. We were talking about contracts just a moment ago, so we'll segue into the next one: have assignment clauses on all key contracts. What do you mean by this exactly, Anja?
Anja: This is really crucial, particularly for smaller businesses. And with smaller business, I really mean businesses realistically that have a value in a sale of less than about $10 million. Because about 90% of these will be sold in so-called asset-based sales, meaning technically you're not selling the company, the legal sale, whatever it might be, an LLC or an S-Corp. What you're really selling is the assets of the company, your tangible and intangible property. It could be customer contacts, it could be actual machinery, whatever it is. But you retain the legal shell of the company.
This causes an issue, because if you have contracts with your customers, or any other material contracts that can be assigned, the buyer of the company has to go out and ask these customers to re-sign contracts, which many times they just simply probably won't do. However, if you have an assignment clause in all of your material contracts specifically say that in cases where you sell the majority of the assets of your company you can assign these contracts to the buyer, that'll make the process much easier, much smoother, and again, it will have an impact on the value of your company.
Jeff: That's huge. And just think about it again. Any time you can make the situation easier on the buyer, and there is less to do or less for them to worry about in this process, and they know that once the business transitions over it's going to, number one, of course, it's going to elevate the value of your company, but it is going to create for a much smoother process. There's going to be fewer headaches down the line, and less of a chance that's someone's going to come back to you later on and say, "Hey look, we need your help doing this. This is something we can't figure out."
I've got Anja Bernier on the line with me, president of Efficient Evolutions LLC. She's a certified business appraiser and CVA as well. You're listening to "Deal Talk." My name is Jeff Allen. We're talking about 10 ways to increase the value of your company, and this is really giving you some things to think about as you prepare to sell your business down the line. It doesn't matter whether that's going to be in three years or maybe even 23 years from now. Number four on your list of the top 10 things to do here: reduce discretionary earnings, Anja.
Anja: Yeah. That is, obviously, once again, one of the ones that apply to almost any company. And because we're obviously talking here about privately held companies. As we all know the typical privately held company has a certain amount of what I would call most people in the industry called discretionary earnings, which means it's the kind of expenses and thus earnings because they really create a benefit to you as the owner of the company that are maybe technically speaking are not 100% business-related. Let's just leave it at that euphemism.
It could be travel expenses where you may or may not have gone to a conference and stayed a few more days. It might have been a meal that you may have spent with a client but you may have also taken out your wife, who knows. Those are just some of the examples. Or you may employ a family member who doesn't actually work there, or you're paying a family member above market rate. So those are the typical examples of discretionary earnings to an owner.
And what it really means is if you have a lot of discretionary earnings, any buyer will sort of expect there is the minimum amount of discretionary earnings in there, and would probably during the sale process, the opening, sort of indicating this and that areas of expenses that would go away if you leave the company. However, if you really put that to an excess, especially if you have a cash-based business and you go even further that you don't record all the cash that comes in, something I certainly don't recommend to begin with. But if that's something or a practice that you have been using, think about it this way:
If you're selling your company, on average you'd probably get about $3 to $5 for every dollar in earnings that you generate. That's a very rough ballpark. Of course, it could be more or less depending on the specifics, but let's just stay with three to five. So for every $3 to $5 you show on your tax return you then only have to pay, if you show it on your tax return for two years given the maximum tax rate being 40%, which means 40 cents on every dollar. So even if for two years on every dollar you pay suddenly 40 cents taxes, which is unlikely. Most companies don't even pay the maximum tax rate, you would end up paying 80 cents over two years for every dollar. But you get during the sales process between three and five for every dollar that you can prove exists.
And those are just some numbers that are important to keep in mind. And this is actually where in many ways I have to say blows my mind on how difficult it is for a lot of business owners to just go ahead and do it. Put it in the tax return, prove that it exists, because again, it's 80 cents in expenses whether it's a potential gain of several dollars. It just really makes sense to do that.
If, for whatever reason, you can't clean up legal issues before you put the company up for sale, at least be open and upfront about it. Disclose all these issues right away. Have the paperwork ready. Very few issues truly will derail a deal as long as you're open honest about them.
Jeff: Ten ways to increase the value of your company. My name is Jeff Allen. I'm going to continue my conversation with Anja Bernier, President of Efficient Evolutions LLC when “Deal Talk” returns after this.
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Jeff: Jeff Allen with you today. Anja Bernier is my guest, and we're talking about the 10 things that you can do as a business owner to improve the value of your company. And that's kind of with your eye on selling your business, and all of us kind of look forward to doing that at some point one day. And Anja Bernier, we really appreciate you joining us today on this program.
This list is something that you came up with a few years ago, and we're kind of going by each one by one. And we've left off on number five. We still have a total of six steps to talk about too, six things here to talk about. Number five, increase profit margins. This sounds simple enough, and it sounds like something we should all be mindful of all the time.
Anja: Absolutely. It seems like a no-brainer, but the reality of the situation is that oftentimes what I see is that business owners lose sight of the fact that driving sales while at the same time recording decreasing profit margins will not do you any good. And that's really the sum of it all. Oftentimes what I see is that business owners will go after contracts just to record the additional revenue without really thinking through how profitable is this additional contract.
And what you should keep in mind is that from a buyer's perspective, profitability tends to be more important than revenue. Meaning that for a typical buyer, a company with $6 million in revenue and $1.2 million in profits, so 20% profit margin, is more attractive than a company with $7.5 million in revenue and $900,000 in profit, so 12% margin. So just because you increase revenue does not mean you're necessarily increasing the attractiveness of your company.
So what you should really be doing is think very hard and long about how do you monitor additional revenue. You should also make sure that, for example, if you have a sales force, that you have incentives plans in place that reward your sales force for getting contracts with higher profit margins and vice versa. In a sense, penalize them for bringing in low margin revenue. So you shouldn't be basically instructing the sales force go out and sell, you should be really more specific about this and say, "Go out and try to get highly profitable business for us."
Jeff: This is something we've talked about on the program before, really apples and oranges when you get right down to it, revenue versus profit margins. Increase those profit margins and work at it. And I really like the idea, too, of incentivizing the sales force in order to help you accomplish that mission.
Number six, get organized and stage the business. This sounds like something that many people might do in their own homes when they're getting ready to sell their home and put it on the market. You're going to stage that home. Is it the same thing with staging the business as well, Anja?
Anja: Absolutely. It really is always true, you never get a second chance for a first impression. And the point is I had walked into many businesses where the office of the owner literally looks like a bomb just exploded there. Or you walk into the cafeteria, it's kind of dirty, it's worn down. It just leaves a very poor first impression for any buyer to walk through. It feels like half the wire is hanging down from the ceiling, the floor hasn't been swept in a while.
Another factor is please do make sure that you've posted all information required by the Department of Labor. Make sure there are no offensive posters, whether that's posters or screensavers. Because the one thing you have to keep in mind, it is the 21st century. Even though you in the past may have thought, "You know what, what's the big deal with having posters of half nude women hanging on the wall? The employees have that." That is unprofessional in today's world.
First of all, it's illegal. It's considered a hostile work environment. But secondly you do have to keep in mind, and I'm not saying this because I'm a woman, because quite frankly when I represent the seller I don't have to work there. But what I can tell you that the buyers and even if they're male they'll look at it like saying you're not running a tight ship. You're allowing things to happen in your company that are illegal. And so do make sure that you pay attention to these kind of things.
Jeff: And it seems, again, like a no-brainer, but really it is true and I've been in these types of businesses before, Anja, as well. And you're absolutely correct; it is very surprising in this day and age when you walk into an environment that is unkempt that looks like it's quite frankly fallen into a state of disrepair regardless of what the numbers show.
Cleaning up the office and staging it or your workplace is not the only thing that really needs spritzing up. But you also need to clean up pending lawsuits. This seems to be a no-brainer, but it's possible that so many people can leave their dirty laundry behind. This is a real big problem that can really quite frankly pose a tremendous hurdle to a sale going through.
Anja: That is very true. Obviously there are many reasons why people may drag their feet on solving legal issues. It can be a lawsuit, it could be any other issue. And I should also say that before making any decisions about legal matters you should obviously always consult with the attorney because every situation is unique.
But that said, in general broad terms buyers really do not like open litigation, open legal issues. It's going to be a major turnoff, it's going to decrease the value of your company. At minimum what it's going to do is drag out the due diligence period. And if any business intermediary like myself will tell you, dragging out the due diligence period is never a good thing. Time is the enemy of every deal. So you want to be hopefully in a position where you have resolved any major issues.
That said, if for whatever reason it might be you can't clean up legal issues before you put the company up for sale, at least be open and upfront about it. Disclose all these issues right away. Have the paperwork ready. Very few issues truly will derail a deal as long as you're open honest about them. And also, if you can, present a path on how to resolve them. So do get your attorney involved. Be ready for this. And do not try to hide any issues like that.
Jeff: Talking about the top 10 things that you can do to improve the value of your company prior to sale. Number eight, be a big fish in a small pond. That's something that I feel comfortable doing. I don't know about you, Anja, but exactly what do you mean by this?
Anja: What I mean is that typically speaking when you're being acquired, the preference typically is that you find a strategic acquirer who would buy you out. Because strategic value is typically the highest value that you can achieve for you company. And what strategic usually do when they do so called roll-ups, meaning they look around and see the companies that we want to add to our portfolio. They usually go after the well-known entities first. So you do want to be a known entity, a big fish in your small pond.
The problem is if you get into a bigger pond, because if you're privately held, smaller abilities, smaller scale. It's very hard to be a noticeable entity. So do find yourself a pond in which you can get well-known, where you can build yourself a position where you are the known leader in something, the known expert, whether that's the best service provider, the best technology, whatever it might be.
And, ideally, also build up a portfolio of proprietary know-how or intellectual property, whether that's patents or something like that. Because that will also be something that will make you more attractive. I give a very concrete example. You might be a manufacturer of ozone monitoring and then controlling equipment. That's a narrow field, so a small pond compared to the large pond of scientist and instrument manufacturing.
Ideally you would become the known expert in manufacturing or zone manufacturing and controlling equipment. And then you try to expand your customer base, either geographical or industry diversification. So that would really be an ideal strategy where you address this point of being a big fish in a small pond. And also the very first point we've discussed today about that you should always try to broaden your customer diversification.
Jeff: And you can do that by virtue of being this go-to expert, someone in your field I think is very important indeed. We got two left here. Number nine, spread know-how.
Anja: That is something that also applies to most privately held businesses. The issue with the typical privately held company is that most of the know-how and expertise is concentrated in the owner. But think about it, you as the owner, you're trying to sell the company. So realistically you will be leaving the company soon. So the more of a concentration of customer contacts, then their contacts and know-how is on you, the more of an issue you're creating, and this, again, decreasing the value of the company because the buyer will perceive that as a risk.
The way you may look at it is like, "Well, it's not a big deal. I'm willing to stay on for a certain amount of time to transfer all these contacts.” The buyer will look at it and say, "Well, what if I buy the company next month and the next day this guy gets hit by a bus? Or this person isn't cooperative during the transition process?” So a buyer isn't just going to look at it and say, "It's not a big deal; we'll just do that in the transition period." A buyer is going to look at you and say, "You know what, that's high risk. All of it is really concentrated into this one person.” So in the years leading up to the sale, do yourself a favor, start spreading know-how to your employees.
It comes back to, again, like we were saying before, if you have 50-100 customers, it's unlikely they're all going to leave at the same time. The same is true with employees. Obviously, you don't need to spread your know-how to 50 different people.
But let's say even if it's three to five, it's very unlikely from the perspective of a buyer that three to five employees will all leave within a few months after they take over the company. So that's much less risk than having all the know-how concentrated in one or two people. So you should definitely start spreading it and make sure that the company can literally run without you, even probably before you sell the company.
The ideal company to be sold is one that if as of the day of the sale you would literally disappear, it would still more or less work the same way it did before.
Jeff: And we've come down to the end of our list here, item number 10. We'll review the previous nine here, Anja, real quickly. Number one, increase customer diversification. Number two, develop recurring revenue streams. Number three, have assignment clauses in all three contracts. Number four, reduce discretionary earnings. Number five, increase profit margins. Six, get organized and stage the business. Number seven, clean up pending lawsuits. Number eight, be a big fish in a small pond. Number nine, spread know-how. And number 10, the last item here on our list that you can do as a business owner to increase the value of your company, create golden handcuffs for key employees.
Anja: Yes. This goes hand in hand with the topic we had just talked about about spreading know-how. Typically speaking it's always a good idea to structure a sale in a manner that you set aside a certain amount of the sale proceeds, whatever you feel is adequate. Again, that's very situation-specific. Let's say 5%-10% of the proceeds. And you basically give your key employees incentives, bonuses, that state that they are eligible to receive this share of the set aside amount if they're still with the company 12-18 months after the sale of the company.
This will very much alleviate the fears of a buyer, of key people leaving. And will basically make sure also that these employees are committed to the sale of the company, say the right things at the right time because they have a vested financial interest in the acquisition going through. Just think about it. For employees a sale of a company and such, or we see acquisition by a new buyer, that's a time of change, a time of uncertainty. They might be afraid for their job.
So this is a time where you can expect that they may actually try even to, whether it's subconsciously or consciously, sabotage the sale. Because for them it's really better if things stay the way they are. That's safety. That's what people like.
So you want to excite them about the sale. You want to have their commitment. You want to have their support. And by giving them an incentive like that you achieve two goals. First of all, they get a vested interest, like I said, in having the sale go through. And then secondly you alleviate the fears of the buyer that they may leave. So you're basically just achieving two things with one action.
Jeff: You're creating some assurances on both sides that there is going to be a tomorrow, and that there will be a reward essentially for those who stay on board, those among your employees. And at the same time you're providing some assurance to the new buyer that things are going to continue to operate normally with these world-class employees that you have on board.
Anja Bernier, I really enjoyed this discussion. We've run out of time. But what I'd like to do right now is give you an opportunity to just say a little something about your company and let people know how they can reach you. We've got business owner listeners to "Deal Talk" all across the country and in your particular neighborhood as well. How can they connect with you?
Anja: That's very easy. As you mentioned before we're actually located just outside of Boston, Massachusetts. Our company that is focused on buy and sell set representation and business valuation. Typically, the transactions that we handle have a value between $1 million and $20 million. That's our specialty across many industries.
The best way to reach us is either our website, which is efficientevolutions.com. And/or, obviously, by giving us a call, and the number would be 781-806-0880. But again, you know, all of the contact information is on the website, and that is efficientevolutions.com.
Jeff: There you have it. Anja Bernier, president of Efficient Evolutions LLC. Thank you so much for agreeing to join us. We enjoyed having you on this edition of Deal Talk.
Anja: You're very welcome.
Buyers love recurring revenue streams. And when it comes to valuation, I can tell you an appraiser will put higher value on a recurring revenue stream typically than on non-recurring.
Jeff: Make sure you tell a friend about "Deal Talk." In addition to morganandwestfield.com, you can find us on iTunes, Stitcher and Libsyn. "Deal Talk" has been presented by Morgan & Westfield, the nationwide leader in business sales and appraisals. Learn more at morganandwestfield.com. My name is Jeff Allen. Thanks so much for listening. We'll talk to you again soon.
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