Know Your Business

They say knowledge is power.  When it comes to selling your business, this is certainly the case.  It’s not that knowing your business inside and out will get you a premium valuation – that should be the baseline as a business owner.  In this article, we’ll explore common issues that I see when taking businesses to market and identify why your inability to explain them may cause Buyers to discount your valuation.  

Multiple Locations

·         Do you have P&Ls broken out for each geography, or are your financials consolidated?

·         How do you allocate corporate overhead to each geography?

·         If a client is served by both geographies, or an employee serves clients in each geography, how do you allocate those revenues and expenses?

If you do not know how much income each of your locations earns, how can a buyer appropriately value the operation? Perhaps the business can be split in two and the sum of the parts is worth more than the whole.  Or, perhaps one location is a drag on business and should be shut down.  I’m currently working on a transaction with multiple locations where a Buyer only wants to purchase one location.  In this instance, breaking down the individual P&Ls is the only way to appropriately split the business and obtain financing. 

Multiple Divisions

·         What % of revenue is generated from manufacturing versus service or wholesale versus retail?

·         What is the gross margin of each division?

·         What % of gross profit comes from manufacturing and services?

If your gross margin is a moving target from year to year, it could raise any one of a number of red flags.  Perhaps you do not take end of year inventory, so the profitability you are representing is inaccurate.  Maybe you are cutting prices because the competition is getting more challenging to compete with.  Perhaps you are increasing prices, but you only have a temporary increase in margins until your clients leave you in 6 months.  It would be a shame to raise red flags if they do not truly exist.  Perhaps the true explanation is that your higher margin division is growing at a faster rate than your lower margin division.  This is a much easier discussion if the appropriate data exists to tell the story.

Recurring Revenue Businesses

·         How many clients do you have? What is your revenue/client?

·         What % of revenue comes from your recurring revenue contracts versus a la carte services?

·         How long have each of your customers been with you?

·         Who maintains the relationship with your client?

Buyers will want to peel back the onion to understand the composition of your business.  Your financials may show that revenue is up, but it’s unclear if that is due to growth in the number of clients or growth in revenue/client.   It’s not out of the question that those two metrics could be going in different directions.   Fewer clients with greater revenue may be great when you have 1,000 clients.  It may be more alarming when you have 10.  Perhaps one client had a 1-time project and excluding that project, revenue would have been down.  The more you can articulate and describe the trends that are happening in your business and why, the higher degree of confidence a Buyer will have that those trends will continue.

Basic Financial Questions

·         What % of revenue do your top 10 customers represent?

·         Do you have any customers that represent over 10% of revenue? 20%?

·         What % of revenue is generated by the efforts of the departing owner or key employees?

·         What % of revenue came from key referral sources?

Remember, it’s not about how good the business is doing now, but how well it continues to do after you are gone.   Are you tracking the key items that make up your P&L? You have to be able to identify that these issues exist in order to be able to address the solutions.   

Financial Anomalies

·         Why is revenue up 15%, but income is down 20%?

·         Why did your gross profit increase/decrease 15%

·         Why did wages as a % of revenue increase from 25% to 35% last year

·         What is that big six figure professional expense that only shows up in 2014?

When looking at financials, they often tell a story.  Perhaps you hired a new CPA and they reclassified items on your P&L.  There may have been a year that you relocated your operation so had various 1-time expenses in the form of professional fees.  Maybe you used to work in the business 60 hours/week but hired a manager to bring your hours to a more manageable level which had the impact of increasing the wages as a percentage of revenue.  Make note of when key events happen and be ready to point them out before Buyers ask questions.  If the concern arises about the quality of your earnings and financial statements, a Buyer may be gone before you have a chance to set the record straight.

In several of the examples I gave, the information you will be asked to produce may not be readily available if you do not put the systems in place early.  Going back to break out a P&L by geography or division can be a laborious task.  It can be equally mind numbing to go back into old data files of invoices, client files, vendor files, or P&Ls to be able to provide an answer that could have been at your fingertips if using the proper technology and tracking over time. 

As we discussed in the last newsletter, when you are selling your company, a Buyer is purchasing the future cash flow.  If you are trying to sell them on how rosy the future will be, that is difficult to do if you cannot accurately describe the past.  If a Buyer is concerned about your answers, that perceived risk will turn into lower offers. 

Know your business.  It will help in a sale and allow you to make better day to day decisions should you be operating for years to come.