Oct 03, 2010
by Bruce Juhola
In last month’s column, we discussed Valuation and the need to know the current value of the business to determine if the owner’s financial objective can be met through a conversion of value to cash. What if the value will not meet the owner’s objective? How can he/she increase the value?
What do buyers look for in a prospective business acquisition? The characteristics buyers seek must exist before the sale process even begins. It is your job as the owner to create value within your business prior to a sale.
The items, common to all industries, which drive up value, are called Value Drivers. They include:
• Management Team - a stable, motivated management team
• Operating Systems - that improve sustainability of cash flows
• Customer Base – a solid, diversified customer base
• Facilities & Equipment - facility appearance consistent with asking price
• Business Strategy - a realistic growth strategy
• Financial Controls - effective financial controls
• Sales & Cash Flow - Good and improving sales & cash flow
The reason a buyer is willing to pay a premium price centers on his or her perception of risk and return. If the characteristics that buyers find valuable – characteristics that both reduce risk and improve return – are present, a buyer will pay top dollar. Buyers will compare both risk and return to alternative investment opportunities.
Value Drivers are characteristics of a business that either reduce the risk associated with owning the business or enhance the prospect that the business will grow significantly in the future. There are many items that create value including: proprietary technology, market position, brand name, diverse product lines, and patented products. In this column, and in subsequent columns, we will look at the key Value Drivers common to most businesses:
• Management Team
• Business or Operating Systems
• Customer Base
• Facilities & Equipment
• Business Strategy
• Financial Controls
One of the most important Value Drivers in any business is its management team. This team is comprised of those people who are responsible for setting company objectives, monitoring the activities, and motivating the workers.
In many small companies this “team” consists of one person, generally the owner. To build a championship caliber organization, however, the management team should include people with a variety of skills. Surrounding yourself with quality people whose skills are different than yours is a necessary preamble to a successful sale.
Management teams are valuable because good teams are hard to assemble, and even harder to keep together. In the investment banking business, the adage is: “Great management teams are worth their weight in gold, because no matter what happens they find a way to win.”
How, then, do you keep management in place until you sell the business? Motivating and keeping key employees is critical, whether you sell to an outside party (who will pay more for a company with stable motivated management), or sell to an insider (who will run the business after you leave).
You should consider several techniques to motivate and keep your key employees, such as:
Stock or equity based incentive plans including:
• Stock bonus
• Stock option
• Stock sale
Non-equity incentive plans including:
• Cash bonus
• ‘Nonqualified deferred
• Phantom Stock plan
• Stock Appreciation Rights plan (SAR Plan)
To be meaningful, incentive compensation must be substantial and frequent. Part of incentive compensation should be paid currently and part deferred to be received by key management only if they stay long-term. This deferred compensation is typically subject to vesting.
In future columns, we will examine in detail the other Value Drivers: Business Systems, Customer Base, Facilities & Equipment, Business Strategy and Financial Controls.