Developing a Solid Customer Base

An important Value Driver is development of a solid customer base.

When you put your self in the buyer's shoes, you will find that you will pass by companies with great management teams and excellent systems but whose cash flow is dependent on one or two customers.  Why would they want to spend millions of dollars on a business only to have those customers go elsewhere, after you have acquired the company?  At the very most, a prudent buyer will structure a buyout to protect against the loss of a key customer, probably by having much of the price of the company contingent or requiring the seller to carry a note for the bulk of the purchase price with the right to offset the note if a major account leaves. 

The goal of a business owner is to have no single account to account for more than 10% of all sales.  A large customer base helps to insulate a company from the loss of any single customer. 

Achieving this objective can be problematic when you have a few clients that are willing to pay for everything you deliver.  If this is where you have found yourself begin now to reinvest your profits into additional capacity that will make developing a broader customer base possible, and /or acquire customer diversification by buying another small company.

Joan

Sunbelt Business Brokers, Greater Bay Area | (408) 436-1900 | www.sunbeltbayarea.net

WHY USE A BUSINESS BROKER?

Business owners often find themselves unsure as to whether or not they should use a business broker for the sale of their business. As an experienced professional in this industry, I genuinely believe that using a business broker is vital in the sale of a business. A business broker acts on your behalf and can successfully guide and execute the sale of your business. Consider these 6 reasons:

1. Confidentiality - Business Brokers specialize in confidentiality. Every business sold is a confidential transaction. It is particularly important remain anonymous if you do not wish your employees, banks or clients to find out prematurely that you are planning to sell. Employees may become worried about the security of their employment, and clients may become concerned about quality and service. Using a broker ensures confidentiality.

2. A Broker has Experience - A business broker has the experience to handle the sale of your business in an efficient and professional manner. They know the procedures, the forms required and the proper methodology to protect you during the sale process. An experienced business broker who has spent a number of years developing an understanding of the current market and acquisition process can be invaluable in helping you sell your business.

3. A Broker knows how to Market your Business - A Business Profile and/or a Confidential Business Review are tools that a broker uses when promoting the sale of your business. A Business Profile is a single page marketing piece, while a Confidential Business Review is much more detailed and is about 10+ pages long.

 4. A Broker already has many Potential Buyers - Your broker and the other brokers in the brokerage will have thousands of qualified and experienced buyers in queue which means your broker will be able to find those interested in purchasing a business like yours.

5. A Broker lets you Maintain a “Business as Usual” Mindset - Nationwide it typically takes six to seven months to sell a business, but it can take up to a year. You will want to get the best price possible for your company, and that means your business has to continue to function as usual. Maintaining the status quo helps make sure that employees feel secure and don’t contemplate leaving, and that clients know service and quality will be maintained. If a business is for sale, it is especially important to make sure that everything continues in the same efficient manner.

6. A Broker will Co-Broke – A broker will cooperate (Co-Broker) with other brokers in the market. This means you are being seeing by many eyes and the most exposure you can get will expedite the sale. The exclusive broker will share their commission with the cooperating broker.

For additional information, contact Sunbelt of the Greater Bay Area. Or give us a call at 408-436-1900.
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How to Use EBITDA to Value Your Company

It's not the only number potential buyers look at, but EBITDA will give you a solid idea of how they'll start evaluating your business.

Looking to the future, can you envision a time when you might want to sell your business?

The best way to build a company is to build it as if you're going to sell it. It has to be built to last.

One place to start measuring your company's potential value in a sale is determining your EBITDA, or earnings before interest, taxes, depreciation, and amortization. It's certainly a mouthful, but the equation itself is really quite simple: subtract expenses from revenue (excluding interests and taxes) without depreciation and amortization (what you pay for tangible and intangible assets). The remaining number paints a basic picture of your profitability as well as your ability to pay off what it owes.

It's a quick way to assess the firm's ability to pay back interest or debts. EBITDA can be thought of as a "quasi-estimate" of your free cash flow, a more traditional and comprehensive assessment of a company's performance. You can get a more accurate reading of your free cash flow by subtracting out new capital expenditures for that year. Once you get this dollar amount, simply build upon the foundation to see how well you are doing.

Day 1: Understanding EBITDA: Add and Subtract Value

It's unlikely that you as the business owner would be fiddling around with your company's EBITDA. Still, before you sit down with the buyers or investors who will, it's important to understand what they'll be looking at.

Essentially, EBITDA on its own makes for a fairly futile statistic. There is, after all, a very good reason why you depreciate and amortize assets. To simply put those charges back in to earnings may give an unrealistic measure of your finances.

That's where the need for adjustments comes in. Since EBITDA is technically a non-GAAP figure, meaning it does not conform to generally accepted accounting principles, you can make these adjustments almost wherever you see fit. As just mentioned, you might need to devalue assets like old equipment within the overall number. Likewise, you also might have failed to collect some accounts receivables from clients. These result in a net-negative for your operating cash flow.

By the same token, you can also add both tangible assets (like equipment) and intangible assets (like your management team and employees) to the figure. It's typically through this addition process that you arrive at your company's value as a multiple of EBITDA. Let's say you pay yourself a $300,000 salary for a position that someone – like a buyer or competitor – could do for $150,000. That buyer would then add that extra $150,000 back into the value of your company once its absorbed. In this case, the number you arrive at is a form of adjusted EBITDA called "field" EBITDA, where you take into account subsidiaries and components of a company that can be absorbed for little to no cost. The term most often applies when selling the business to one in a similar field, in which case the management team, office space, and other business expenses may fall by the wayside during the takeover.

Business Buyer's Market?

With all of the layoffs from Wall Street and the Financial District, there are more buyers in the market looking for a business. This, coupled with the fact that some businesses are experiencing a downturn along with the market, prompts buyers to come in with an offer that is far below the listed price. Granted, some businesses are experiencing a drop in gross sales, and their original price may need to be lowered; however, there are still some local markets experiencing stability and some even growth. It is, therefore, important to not value or price businesses based solely on the current national economy.

Sellers often must face the reality of what their business is really worth, not what they would like it to be worth or even what they need to sell it for. When business brokers begin preparing businesses for market, they will typically look at the last three years tax returns, profit and loss statements, and balance sheets. They take this information and recast it, adding back items that the next owner might not run through the business since they aren't necessary to running the business such as country club fees, manager's salary, etc. Based on the recasted financials and comparative sold businesses, a multiple is arrived at for the Seller's Discretionary Earnings (SDE), i.e. 2.5 x $130,000 equals the listing price of $325,000.

The most important aspect of pricing a business is still the most recent historical financial performance and how the business is currently doing. For the businesses that are continuing to show strong financials even though their market area may have a high unemployment rate and other local economic downturn indicators, there would be no reason to decrease the purchase price of those businesses. In fact, businesses that are continuing to do well in current economic times may actually be worth more than originally thought.

Buyers should be on the look out for those businesses that are doing well in the current economy. A good case could be made for decreasing one's risk by purchasing a well-performing business instead of just rying to buy a business at the lowest price. In the long run, the buyer may see a higher return on their investment.

Misconception for Small Businesses

So many people assume that when there is a recession that small business must shrink. Not only does the small business market offer continued growth during a recession, it also offers relative stability. Take a look at the growth rate of the small business market versus that of consumer spending.

Consumer spending sports impressive growth rates during the best of times but also suffers big swings during recessions. Conversely, the small business market offers a more stable source of revenue through good and bad economies. Year after year changes in the small business growth rate are less than a third of the drops seen in discretionary consumer spending.

Small business is not only an important source of diversification for enterprise companies but also a relatively safe haven for investments during recessions.

Being Flexible During These Changing Times

You must remain as flexible as possible if you plan on selling your company or making an acquisition while these weak credit conditions are occurring.

If a good opportunity comes along you will need to act quickly. Quickly does not mean skipping any of the due diligence steps required. Using experienced advisors can assist you in evaluating a potential deal and help you include escape clauses in your purchase agreements to provide an exit.

CLEAN IT UP!!!

Well it just happened…. I am always advising potential sellers to have their books cleaned up, their files in good order, etc. before putting their business on the market. I am representing the buyer and co-broking with another broker in another office. It started off wrong. The broker would not provide the Trailing 12 month financials. This is an easy thing to get if one is using QuickBooks. We made our offer contingent on getting those numbers, which showed us that the last 12 months were down 20%. We still moved forward…

When due diligence began, the files were a mess. The Seller gave the Buyer incomplete employee files and wasn’t sure where two of the employee files were…RED FLAG… The sub-contractor fees were $100,000 higher on the tax returns than were reported on the P &L’s… RED FLAG. The 1099s that were given were the red copies which are the ones that are suppose to be filed… Were they filed? RED FLAG. The
Tax return showed a combination of his wife’s business and his business. Now we also need the wife’s business financials so the tax returns make sense.

When the Buyer inspected the equipment and vehicles, only one vehicle was insured out of five total, and one quarter of the equipment needed to run the business was in need of repair, which will amount to over $10,000. There also was a new fee that has been imposed for the equipment that will add $850 per month in expenses.

In summary, this deal will never happen, and it didn’t have to be this way. If the broker had advised the Seller to get his ducks in a row prior to listing this business, it would sell. It is in a hot industry. The Buyer REALLY wanted it to work out, and even if the price is lowered considerably, now the Buyer really doesn’t trust anything that he is given due to the mess the business is in.

Before selling, get things in order. Look at your business as if you were a buyer. Would YOU buy it the way it is now?

Time to Leave But Don't Want to Let Go? Reinvest in Your Company.

You can have your cake and eat it too.

I was working with a client who had done an amazing job building his company but was toying with moving on. He had grown it to earn five times what it was making when he acquired it and added new products and loyal clients. No one customer made up more than 5% of the revenue, and the company had 50% repeat business. Sweet situation. Why sell?

The seller was bored and wanted a new challenge but knew if he kept the company a few more years, he could double it.

Solution--the seller decided to re-invest 20% of his proceeds from the sale back into the "new" company. The acquiring company had deeper pockets to build it to a much larger firm and had skill sets that would allow that growth to happen.

The seller now would be able to build another venture to hold his interest while he continues to increase equity in the business he built. This also, of course, gave the acquiring company comfort knowing the seller had enough confidence in the firm and the industry to put his money where his mouth is.

Transferring Ownership in a Small Business

Just because a company has a key employee who knows a lot about the business, its operations, customers, and employees doesn't necessarily mean they should stay indefinitely.

I sold a temporary help business last year, and the key employee would only sign a six-month employee contract. At the time, this was a concern for the buyer. After one month of owning the business, the owner was counting the days until the six-month contract expired. With a key employee having a lot of knowledge but a bad attitude, not always honest, not a team player, and only out for himself, the company would not thrive and grow with him involved.

The new owner started interviewing and found several excellent candidates that he would enjoy working with--Oh, by the way, for less money and fewer perks than the previous employee was getting.

Capital Gains Tax, the New Administration and You!

Sellers should be considering taking advantage of the low capital gains treatment on the sale of their company since the standard top on long-term gains rate is 15%, but it is set to rise to 20% in 2011. Then we need to consider that the Democratic administration is expected to raise the capital gains rate to 30% within the next four years. This will not only have a great impact on investors in stocks, real estate, but also businesses being sold. This is particularly important for a business owner who is contemplating an exit strategy within the next three years, weighing whether it makes more sense to grow the business and pay an extra 15% in capital gains tax down the road or sell it sooner for a little less but keeping more of the profit.

These business owners also should be aware that where will be a glut of available businesses on the market and a downward price pressure in the next few years due to the fact that there will be more sellers than buyers.

If you have been considering an exit strategy now is the time to be getting your company ready so that your are prepared when the timing is right for you.

What if I've only been in business a short time, barely breaking even and want to sell?

We are receiving many calls from companies that have been in business for fewer than two years, and they would like help selling their companies. One of the first questions we ask is, “Is your business profitable?” The response is typically, ”We are breaking even.” or "We are getting there."

Not only is it difficult to find a buyer for a company that has a history of fewer than three years, but by not being profitable or not having at least $100,000 adjusted net makes it close to impossible. The owners of these young struggling companies typically also want to recoop their entire investment including working capital.

Think about it. If a buyer could get into a business that is making $100,000, and they are asking $265,000 versus one that is asking $265,000 and breaking even, which one would you choose?

It is too soon for that business owner to expect to be able to recuperate their investment. Our advice is to either raise more capital so that you can grow the company to a place where it is saleable or possibly bring on a partner who can do what the owner is obviously not doing well. If the owner decides to close their doors, they will still be on the hook for the property lease and any equipment leases that have been signed.

There is help out there. The Service Corp of Retired Executives (SCORE) or the Small Business Development Center (SBDC) offer free advice to business owners. They have offices in most major metro areas.

Be careful before jumping into business. It is safer to invest in an existing business with a history, customers, employees and cash flow versus starting from scratch. If there is nothing available on the market that interest you...WAIT. Be patient for the right one that will utilize your skills, interest and that will be able to help you reach your goals for your next career.

How does the softening economy affect business brokerage?

With the economy softening, you would think that business would be slowing down.

What I have noticed for the last few months is that there are fewer buyers calling; however, those who are looking at businesses are dead serious. The buyers know what they are looking for, or at least the criteria for the business. They are able to evaluate the Confidential Business Review or Offering Memorandum and move towards a Letter of Intent (LOI) in a timely manner.

The selling market is still strong.

Seller's want to take advantage of the low capital gains treatment on the sale of their company before the new administration plans to raise them. They also know that there will be a glut of available businesses on the market and a downward price pressure in the next few years. They would rather sell before it becomes more difficult to compete with so many others.

There is a Private Equity Boom happening as well.

The interest level of private equity funds in middle-market companies is still very strong. More players and abundance of capital continue to fuel the growth. For smaller private companies, private equity funds can deliver much needed financial resources such as liquidity, growth or acquisition capital, and greater access to lender markets. They can also provide liquidity for companies that are turning the business over to their children or a change of ownership.

Ultimately, for those thinking about selling their business, there is no time like the present before there is too much competition in the marketplace.