A business owner can take a few well-known steps to raise the value of their company, such as ensuring well-documented processes are in place and having a strong management team actively involved in decision-making.
But there are also lesser-known steps that can dramatically influence what your business is worth. These steps tend to relate more to having an active management style than to a set of universal truths. Many of these extra actions seem obvious once you consider them, but only a handful of entrepreneurial companies put them into practice. The good news is that almost any company can consider them. Ron Brown, CPA, CA, a partner with MNP in Saskatoon, has seen several situations where smart decisions made years ago are providing shareholders with sizable returns today. “It’s interesting to see how a little contemplation for the future goes a long way,” Brown observes.
The performance of any business is strongly influenced by the health of the economy. Since companies are generally valued based on earnings, the operating environment has a significant effect on what companies are selling for at any given point in time. It is crucial to understand the market and know the optimal time to exit.
Always be ready to sell.
Brown considers timing to be a key factor in a company’s selling price. “Companies that are trading at multiples of four to five times earnings today may be lucky to get an offer at some time in the future should the industry be in a decline. We are living in uncertain times and technology is disrupting how business works, which will ultimately impact value.”
The lesson is to consider how today will relate to the future. If you have a favourable sale price on the table but you are not personally ready to sell, consider doing it anyway. Several years of hard work to improve your business might actually mean a lower selling price if the market is not in your favour when you do want to sell.
The point is to understand your situation in the context of the bigger picture and to be prepared to exit at any time. “Always be ready to sell,” advises Brown. That means more than just paying attention to timing. It also means having your house in order at all times. “When considering company value, are you referring to after-tax proceeds in your pocket, or to enterprise value? The legal arrangement of how your business is organized, the corporate structure, may have a huge influence on taxation. Quite often if the business is properly structured you can respond when the market timing is right and make sure you don’t leave any money on the table.”
If the business is properly structured you can respond when the market timing is right and make sure you don’t leave a lot of money on the table.
Part of thinking ahead is understanding who your ultimate buyer might be. You can even restructure your company in a way that is attractive to certain types of buyers. For example, some private equity firms that may buy a portion of the business may prefer a partnership structure to a corporate structure for tax reasons. A business owner may also want to think about separating land and buildings under a separate holding company, as most financial buyers are not interested in
purchasing real estate. This also provides a layer of creditor-proofing.
PEEL BACK THE LAYERS
Just like peeling back the layers of an onion, business owners who examine what’s not obvious in their business will discover opportunities to increase value. One such opportunity is knowing the rate of return the company is generating from its capital investment in the business. With that information, the business owner can examine the cost of financing used to grow the business. “Understand your capital structure, and in particular your cost of capital,” Brown explains. “If your rate of return does not exceed your cost of capital, you are probably going down the wrong path.”
Brown has plenty of examples to illustrate how a proper capital structure can allow a company to take advantage of new opportunities. He tells the story of one client that had an opportunity to buy product that would result in additional earnings for the company. The problem was that the firm was lacking the working capital required for growth. In this case the owner was able to increase his operating line, which added roughly 30% to company profit. Even though the company was required to obtain higher-priced capital to secure the operating line, EBITDA (earnings before interest, taxes, depreciation, and amortization) went up. So did the value of the business, because valuation is normally a function of EBITDA.
Examining your business can reveal situations that have surprising implications for the potential sale of the company. One such area is the structure of staff compensation. When staff salaries and bonus structures are higher than market rate you may end up in a situation where a potential buyer is not able to align its pay structure with that of the acquired company. If the buyer is unable to do it, the compensation structure may negatively affect your ability to sell your business.
When considering how to increase the value of a company, it is crucial to maximize the firm’s contribution margin. Whether through marketing, client pricing, or additional services, you have to get the most out of each sale. “I had a client that had not had a price increase in years,” Brown says. “I asked him if his costs were going up. I asked him if his competition charged higher prices than he did. He said ‘yes’ to both. By that point in the conversation he realized he was underpricing his product.
“Complacency is the worst thing. You might not even realize you are falling behind. In this case our client was able to raise his prices and every single dollar fell directly to the bottom line. To be clear, however, the focus needs to be on growing profit, not necessarily revenue.”
MANAGE WHAT’S IMPORTANT
Managing the numbers means being disciplined in tracking and controlling expenses. Most entrepreneurs are busy pursuing growth. They work on acquisitions or chase sales, but they don’t pay attention to other key value metrics in the business.
It is also crucial to manage your time and to look for opportunities to benefit from advice. When selling your business, working with an experienced broker can save you a lot of time. If someone said you could increase value by working three extra hours per day, you would probably say you don’t have any time in the day to spare. Now consider the drain on your time to manage the process of selling your business. Your focus becomes the deal, not managing your business.
These simple tips for building value may seem obvious, but they’re easy to overlook. “Focus on what is important,” advises Brown. “And what’s important may simply be hiding in plain sight.”
First published in the December 2019 edition of The Business Advisor.