Business Valuation: What Else Counts Besides Profits?

Value Drivers of Business Sales by Glen Cooper Business Broker / Business Coach www.GlenCooperColorado.com

Buyers are often attracted to certain businesses for reasons other than reported profits.

They will even pay premium prices for businesses if they see other factors that matter to them.

Just what are these other factors?

That’s what this article is about. Prospective sellers take note! See also the companion article: “Appraising Your Business in 60 Minutes.”

These “other factors” might be called the value drivers (*1) in business sales. For any specific business and for any one buyer prospect, these “value drivers” will be unique. Generally, they can be grouped under seven separate general headings.

What Business Buyers Want If two businesses each have comparable profits, a buyer will pay more for the one that is perceived as attractive or interesting work.

A buyer will also pay more for one that has a market future that is clearly positive, that has the better location, whose operating systems work better, and that has a clearer track record of proven stability.

If, on top of all that, one business has better books and records and is offered on more reasonable terms, it will command a premium price.

● Attractive work

● Strong market position

● Right location

● Working systems

● Proven stability

● Good books, records

● Reasonable terms

It is useful to examine each of these value driver categories, and to see why buyers often pay more than what one would otherwise expect simply by looking at historic profits. _______________________

(*1) The term “Value Drivers” as used in this article is similar to, but not the same as, the term used in business economic analysis defined as “the economic variables that are critical to revenue and cost functions of the business.” In the real world of small business, though, many of the factors listed in this article do fit that definition.

Attractive or Interesting Work Some businesses just look like fun. From time to time, certain businesses are considered “hot.” It should be noted, however, that categories of preference change over time and vary from buyer to buyer, and that it often pays to invest in a business that is NOT popular at the moment.

Right now buyers will pay a premium for services, distributorships and some types of manufacturing, but many retailers and food businesses can be acquired for lower prices and on better terms precisely because they are NOT “hot” right now.

Strong Market Position Corporate buyers just love to acquire market share by buying smaller businesses in the same or similar markets they already serve. This has happened recently in the print media and in construction. Why? Because the future of these markets is made even brighter by synergies that can be created by consolidation.

Individual buyer prospects, too, want to be assured that the future looks bright for whatever they buy. They particularly like a business that has carved out a place for itself that they can understand, one that has a significant market share already but where sales increases are still possible.

A few years ago, I sold Points East magazine to a publisher that wanted to increase market share in the reader market of New England boaters. I also sold a commercial painting franchise where the marketing-savvy buyer saw a rare opportunity to grow market share immediately, even though the business was already dominant in its market.

Right Location Buyer prospects in Colorado love to be near the mountains! They want to live near their work, either near or in the mountains, on a lake or by a river. After that, they want to be in a property that can be purchased or leased on reasonable terms, and which has room for the expansion that they are planning. They also pay a premium for business premises that are well-designed, clean and neat. If they’re buying the real estate, they want to know that it is in the path of growth, so

it will prove to be a good real estate investment.

Location, however, is also “virtual.” Today, the Internet positioning of the business is the “location” that is important.

Buyers seek and will pay a premium for firms with well-conceived Internet websites and a business operation that is well connected with high visibility and a strong following on the Internet.

My sale of MaineLobsterDirect.com a few years ago is a good example of this. The owner was paid a significant premium for inventing a business with a great physical and virtual location. It was on the desirable Portland, Maine waterfront AND it had a great website.

Working Systems All businesses have management systems, marketing systems, sales systems and operations systems. Effective and efficient systems empower employees to be productive and happy. Acquiring a business that has good systems in place is always worth a premium.

Businesses with working systems also maintain their equipment, their vehicle fleet and their computer systems,

keeping everything up to date. They keep their inventory for resale current. They have good systems, procedures and operations manuals.

Systems also keep businesses out of trouble. A business that knows what it is doing is more likely to be in good standing with its vendors and its bank, and is not likely to have pending or expected litigation to worry the buyer.

One of the most successful smaller businesses I ever sold was Shads.com, a promotional specialties company. It’s still successful today, many years after I sold it. Why did its current owner pay my seller client a premium price at the time? One very big reason was that it was set up to make money for him from the very first day. The systems worked. They still do.

Proven Stability Buyer prospects like stability. Unlike the “entrepreneurial” types who start businesses from scratch for the thrill of the start-up process, business buyers are more managerial than entrepreneurial.

They like “turn-key” businesses that already have absorbed all of the initial start-up pains.

If buyers wanted start-ups, they would start them. They don’t. That’s why they buy instead. They want the stability of the business that is already established. They want to know that the seller will stand with them for the transition period.

Seeing the historic trends and structures gives buyer prospects comfort to move forward. They want to avoid making a big mistake.

Good Books & Records If all the other factors above are in place, the business probably also has good books and records. Buyers typically want to see three years of Federal income tax returns, as well as any corresponding financial statements, whether compiled by a CPA, or internal from a program like QuickBooks®, or both.

Buyers like to see detailed sales histories by month and by product line or service, and detail of all the costs and expenses by month for at least the last two years.

They also pay premiums for businesses with good customer relationship management (CRM) databases of past and current clients and customers.

I once sold a one-person service business where, because the owner suffered from Attention Deficit Disorder (ADD), his wife had compiled a super-detailed step-by-step operations manual. It was this systems manual that most impressed the buyers. They paid nearly $125,000 in goodwill for the manual alone!

Reasonable Terms Terms offered by the seller are also critical. The lower the down payment, and the lower the amount of working capital needed, the more buyers there will be who will look at the business. I might have called this “value driver” reasonable price and terms, but we discussed price and profits in the first of this two-article set.

A business with significant tangible assets to use as security for long-term loans is also in a much better position to negotiate a good price.

A business owner who can afford to offer seller financing is in a much better position to command a premium price.

Sellers who run their business as if they are going to own it forever – keeping the pipeline of future business full for a new owner – and who will stay for any needed transition period are also big winners.

50 Value Drivers in 7 Categories 1. Business perceived as attractive, interesting and worthwhile work

• Business purpose engages and interests buyer • Work itself seems attractive • Seems like the right type of business to acquire now • Appeals to wide number of buyer prospects • Business can be run by any talented person with only general business skills • Special licensing NOT needed to own the business • Technical training NOT needed to run it • No special knowledge needed to understand markets

2. Future of market served is clear and seems positive • Market niche served is clear and easily understood • Significant share of, or dominance in, market is present or possible • Growth of market still possible or somehow synergistic to acquirer • Protection from competition for some reason • Diverse, broad-based customer list – no concentration issues • Existence of alternative vendors – no concentration or other supply issues • Pricing of products and services is competitive • Brand names, trade marks, trade names, copyrights, patents in place

3. Location is “right” – where potential buyers want it • Coastal or resort location often preferred • Accessible to transportation, employees, urban center with business resources • Business premises available for lease or purchase on favorable terms • Physical premises allows for future business growth • Website (the other “location”) is well-designed, linked and up-to-date • Business is located in the path of future growth

4. Business operating systems are effective and efficient • Marketing and sales systems are in place • Operations are smooth • Employees are trained and experienced • Computerization and technology up-to-date • Business reputation in market is good • Physical premises kept neat and clean • Furniture, fixtures, equipment and vehicles are all well maintained and performing • Inventory for resale is clean, current and salable • Operations manual, policies & procedures all in place • Credit standing with vendors and banks is positive • No litigation is pending or expected

50 Value Drivers in 7 Categories -continued- 5. Operational stability has been proven.

• Well-run for several years prior to selling • Good growth of revenues on the books • Reason for selling is clear, and not a cause for concern • Transition to new owner appears easy • Profit percentage is stable or growing • Operating expenses seem normal for the industry

6. Books/records/databases are complete and detailed • Tax returns agree with internal books • At least 3 years’ of financial statements are available for inspection • Sales records are detailed and available by month • Cost of Goods Sold and Operating Expenses are well documented • Database of clients/customers current and in place • Permits, licenses, leases, franchise and other business documents are all in order

7. Acquisition of the business is offered on reasonable terms • Low down payment and working capital requirements • Seller financing offered as “bond for performance” • Has enough tangible asset value to attract banks or other 3rd party financing • Business operated to keep future business pipeline full • Current owner will stay for needed transition