Many business owners struggle with the choice of investing in the growth of their business, or selling. In this article we examine a few avenues of growth and how this affects business value.
We’ve seen many instances recently where the decision to sell was primarily motivated by fatigue and burnout rather than retirement. Ideally the after-tax proceeds of the sale of your business will enable the business owner to retire and live the lifestyle they want post-exit. Prior to exploring a sale, you should consult with a value advisor and financial advisor to determine the value of the business today and the net proceeds you need to retire. This is called a wealth gap.
A financial advisor will meet with you and construct a financial plan. In a hypothetical example, they may tell you that $2 million at the age of 60 can be invested in such a way that you can step away from the business and pursue your personal interests.
Your value advisor, whether it is a business appraiser or broker, will examine your business and recent comparable transactions and determine your business will likely sell for $1.25 million. Therefore, the wealth gap in this scenario is $750,000, or the difference between the $2 million required and $1.25 million value of the business (pre-tax).
So, how do you solve for the $750,000 value gap? Here are some value enhancement strategies:
- De-risk and make the business more transferrable.
Invest in the development of your leadership team and employees. Diversify your customers and suppliers. Enhance the quality of your financial statements. Build a CRM “Customer Relationship Management” system that tracks all customer interactions and data. - Add efficiency.
Most small business owners likely have not performed a deep dive of their financial statements to root out any unnecessary expenses or benchmark themselves to industry benchmarks. Analyze your financial and operational performance, create a dashboard of key performance indicators, monitor monthly leadership meetings, and hold the team accountable to meeting your goals. - Grow.
Growth may sound like a daunting task and a lot of work. It involves elements of risk and potentially debt, two elements that an owner typically tries to avoid. Let’s explore some ideas:
a. Organic growth
Organic growth implies growth from within your existing team and customer offerings. Growth can mean revenue growth, but let’s focus on EBITDA or cash flow growth. This path may not be available to everyone. Perhaps the business and team have done a tremendous job at harvest all the value from existing clients, products, and internal resources. If that is you, fantastic. However, we have found that there is often more that can be done.
- Leveraging the CRM system to increase contact with leads, prospects, or existing clients (inside sales).
- Review existing product offerings and profit margins. You may find some products are unprofitable and those offerings can be discontinued. You may find that you have a competitive advantage with a product and can shift more resources to that offering.
- Revenue automation. This term means building a marketing process that generates a constant stream of business. Revenue automation is particularly useful in businesses with high owner centricity. Strategies for revenue automation include increasing online presence, enhancing the website, and investing in search engine optimization.
- Boost efforts in the community or at industry tradeshows (outside sales).
b. New products or services
You may find that there are opportunities tangential to your existing business.
- New markets to enter. Perhaps your product can be marketed for use by another industry.
- New products/services.
- New uses for existing products.
- Add a repair/maintenance line of business, if applicable. This is high-margin, steady work that boosts profitability for certain manufacturers or dealerships.
c. External growth
- Acquire a competitor. There may be a competitor in the industry that is ready to exit or retire. Acquiring the business would decrease competition and add new markets, staff, and efficiencies to your operation.
- Acquire a supplier. Vertical integrations are less common in small business but in some circumstances, you may find that a key supplier is seeking to exit the business. The loss of the supplier would adversely impact your business. It may be worthwhile to explore acquiring the supplier to solidify your access to that product and improve margins.
Financing your growth
Acquisition financing can be challenging. Here are a few options:
Small Business Administration (SBA)
The SBA 7a program allows for business acquisition financing up to $5 million with as little as 10% down. The 7a program is utilized by thousands of buyers annually. Business acquisition terms are 10-year amortization at a rate that ranges from Prime + 2.25-2.75%. The Prime Rate is a benchmark rate that rises and falls based on decisions by the Federal Reserve.
Asset-Based Lending
Asset-based lending allows for the funding of acquisitions through the financing of business assets. ABL lenders take the time to understand inventory, accounts receivable, and equipment very well, and are willing to lend at higher advance rates than traditional commercial banks. The lender may be a source of funding by leveraging previously unencumbered assets.
Private Equity
Private equity groups seek to generate returns for their investors by buying and operating privately held companies. For an owner, this may be a good gradual exit option. Many private equity groups will acquire your business in two stages, allowing an owner to take some personal risk off the table in the first stage and benefit from the upside of growth capital injected into the business in the second and final buyout. For example, you may sell 80% of your business to a private equity group in the first stage. You secure your financial future and stick around to continue leading the business along with your private equity partner. The private equity team invests in the growth of the business and may even acquire and combine other businesses in the same or related industries. In the end, the remaining 20% equity you held may be worth more than the original 80%.
Adding Value
Let’s bring this all together and discuss the relationship between growth and value.
The decision to sell or grow should be made based upon your ability to pursue your passion after exiting the business. If the sale of the business will not generate the required after-tax proceeds, consider methods of enhancing your business value.
You can increase the value of your business without generating any more sales. Make your business more transferrable.
Implementing growth strategies may require additional expenses that reduce profitability in the short term, but these affects on value are easily outweighed by the positive impact of growth. A buyer will pay more for a business with a strong growth story. Any expenses related to business growth in the short run can easily be explained or treated as an “add-back” if you think of value in terms of SDE.
From a valuation perspective, appraisers estimate cash flows into perpetuity. In the Discounted Cash Flow method, we create projections for a finite period (4-5 years) and then apply a long-term growth rate that estimates projected cash flow growth forever. A business that demonstrates a sustainable growth story may earn a higher long-term growth rate and add significant value in a valuation. Conversely, if a business takes steps to reduce risk in areas of the business, the discount rate applied to these future cash flows will decline, increasing the value of the business.
Curious about the value of your business today or potential growth opportunity? Contact AMP Business Valuations for a free value consultation at 720-708-2584 or info@ampbusinessvaluations.com.
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