In my last article I introduced Rick, a business owner who has just started to think about the possibility of selling the business that he has built and run over many years.
The Story Continues
When he got back in his office on Monday morning, Rick had his weekly management team meeting. In general, things looked good. The sales pipeline was strong, and the results of the new customer satisfaction survey were very positive, just as he expected. After 25 years, he knew enough to stay in touch with his key customers and make sure he knew about any issues so he could fix them before they became real problems. Receivables were growing a little faster than sales, so he had his controller set up a calling program to speed up collections.
Arthur, a business advisor who had run and sold a number of companies, had agreed to come by for conversation over sandwiches in his office. Oddly, Arthur was not surprised when Rick told him that he was thinking about selling the business. “I’d be surprised if you didn’t think about it”, Arthur said. “You’ve accomplished a lot over the years that I have known you, and it makes sense that you would want to step away while you are still vigorous and healthy. I’ve had a few clients who couldn’t let go for one reason or another, and they never really harvested the full value of what they had worked so hard to create. It’s a pretty sad situation after a lifetime of hard work.”
“Of course I’ll keep this confidential, Rick, and help you in any way that I can. I’m made sure that you’re your financial information is in order, and you’ve listened to my advice to have an audit every year so that a buyer or investor can trust your information. But, financial statements are only the foundation in preparing to sell. There are lots of other things to think about that go way beyond accounting.”
Selling Your Business is a Marketing Problem
“As I ‘ve watched you over the years, I think the key to your success is your ability to put yourself in your customer’s shoes, to understand what he or she wants and figure out how to give it to them at a price that meets your profit objectives. Selling your businesses is just like that. It’s really a marketing problem.”
“Let’s think about what a buyer (or any investor) wants. Sure they are buying your assets—physical assets like equipment and inventory and intangible assets like satisfied customers and a good reputation—but when you boil it all down, they are buying the cash flow that your business can generate for them. Like any investment you would make in your business, they are looking at the cash return they can earn in future years compared to the cash they need to invest. The higher their projected cash flows the more they are willing to pay.”
“So, what goes into their evaluation? Since they want a good cash return on the cash they invest, the most basic thing they focus on is your return on invested capital or ROIC. This means is how many dollars of capital you have to invest to generate a dollar of pretax cash flow. Sometimes they talk about EBITDA (earnings before interest, taxes, depreciation and amortization) as a good shorthand for operating cash flow. This has to be the starting point to think about what your company would be worth to a buyer.”
Rick nodded and said: “You’ve given me a lot to think about. Let’s meet again next week.”
In my next article, I’ll describe the rest of Arthur’s advice to Rick about valuation for the purpose of selling a business.
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Contact David at david.roberts@newportboardgroup.com
