We have all heard the expression “Cash is King”. Cash flow, especially for a small business early in the life cycle, can make or break the business. My own experience as Vice President and General Manager of a manufacturing facility where we quickly grew the revenue without having the visibility of cash flow taught me a very important life lesson that I now share with clients. In my case the business had most customers on net 60-day payment terms (who typically paid in 90 days) and venders on net 30-day terms. The more we grew the revenue the more we needed to invest in the business since the increase in profits did not keep pace with cash flow.
In Walk Away Wealthy, by Mark M. Tepper, he talks about the importance of cash flow but also the importance of what he calls Value Drivers to increase the multiple of EBITA the owner can receive when selling the business. The Value Drivers he discusses are mentioned below;
A Diverse Customer Base
A company dependent on only a few customers or clients runs the risk of having a significant loss of revenue should they lose a client for any reason. Ideally the business should have a relatively large number of customers to minimize the loss should one leave. Such a scenario is usually not a question of “if” but “when” the loss would occur. Ownership of businesses change, new competitors are introduced, a customer’s brother in law opens a competitive business. Stuff happens so don’t put all the eggs in one or two baskets.
Stable, predictable cash flow
Cash is critical and a growing cash flow will be much more attractive to a potential buyer. This includes things such as reducing costs, improving efficiencies of processes, better employee productivity, and effective marketing strategies/investments. Dollars spent on personal expenses will reduce the value of the company so as a business broker friend once said “if you take it out now you will not get it back later.” Meaning that by taking personal expenses out of the business the value of the business will be reduced by a multiple of those personal expenses.
Strong, independent management
Key word here is independent. Steve Jobs is credited with saying “It doesn’t make sense to hire smart people and tell them what to do; we hire smart people so they can tell us what to do.” From a management perspective know that while you may be the smartest person in the company it is highly unlikely you are the smartest in everything, or for that matter most things. Hire people that are experts in areas you are not and then look to replace yourself. From an outside perspective it makes little sense to purchase a company that is reliant on the present owner to make all critical decisions. Having a strong independent management team makes the purchase of a company more viable as an ongoing concern.
A clear, comprehensive Operations Manual
Systems are key to an ongoing concern. Let the systems operate the business and have the owner and management operate the systems. Document everything in the business so there is no question how processes are to be performed. Nothing should be assumed. Typically a business will grow organically with processes evolving as team members or management decide how things are to be done. Unfortunately unless written down there is no consistency. If a team member leaves so goes the process. In addition to increasing the value of the business at the time of transition for a business, a comprehensive Operations Manual will immediately benefit the business with increased efficiency, better consistency, happier and more productive team members, and more profit.
Solid Financials
Have financial reports prepared by a qualified CPA. The reports should be logically presented and in a format intuitive to the type of business. Just as important is that the owner and team members that are privy to the reports need to fully understand where the numbers came from and where they are headed. Part of the transition will undoubtedly involve discussions with the new owner regarding the financial reports.
Proper legal structure
Talk with an attorney and CPA regarding how to structure the company. This has implications on taxes while for the present owner as well as at the time of transition and the owner needs to have a working knowledge of these differences. The discussions of the options to legal structure are beyond the scope of this paper and should be reviewed with an attorney and CPA sooner rather than later.
Growth prospects
Buyers will offer a higher multiple depending on the growth anticipated in the industry and then how the company is poised to participate in this growth. Having a forecast as part of the financial data will go a long way to keep the team focused on growth participation and then communicate this during any transition discussions.
By focusing on the value drivers owners will attract a higher quality of potential buyers and at higher multiple. Additionally the business will operate with greater efficiency and provide both the owner and all team members with improved satisfaction in their work as they see the business grow.
As providers of service to small business please keep these principles in mind and share this information with your clients as appropriate
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