Thursday, December 26, 2013

How to Double the Value of Your Business in Two Years

As we approach the beginning of a new year I reflect upon our firm’s achievements and challenges over the past year.  Celebrating accomplishments and monitoring progress towards goals are vital to your continued focus, commitment and motivation.
 
How did your business do this year compared to your original goals?  Are you on track to exit your business at a time of your choosing?  Has your business increased in value over the past year?  Would you like to double the value of your business within a two year period?  It may be challenging, but it can be done. 
 
Smaller start-up companies can increase in value quite quickly, particularly if they are able to create their own market or are successful at penetrating and finding a niche in an existing but growing industry.  Increasing the enterprise value [1] of a larger and more mature company, however, is generally much more difficult. 
 
Two of our clients at VSP this past year actually doubled their enterprise value within a two year period - and these clients were not small, start-up companies.  Having conducted a business valuation two years earlier, we were asked to update our valuation this past year.  One was required for tax purposes and the other was required for planning purposes in connection with a potential shareholder buyout.  One business has been a service provider for 15 years and had over $30 million in annual sales.  The other company has operated as a manufacturer for over 40 years and had over $50 million in sales. 
 
You may be wondering how two mature businesses in separate industries were able to double their enterprise value in two years.  A quick review of our valuation analyses reveals the following top 5 common factors contributing to this achievement:
 
  1. A Business Plan - both companies had business plans in place two years earlier which included financial projections showing modest growth rates in sales and EBITDA going forward;

  2. Recent Growth - both companies experienced recent growth and actually exceeded the sales and EBITDA targets set out in the financial forecasts from two years earlier;

  3. Future Growth - both companies had updated their business plans from two years earlier and increased their financial forecasts going forward.  The fact that earlier projections were documented and the company actually exceeded targets enhanced management’s credibility with respect to the growth projections going forward;

  4. Tangible Asset Backing - in order to support the recent and future growth, both companies had reinvested in the business thereby increasing the net tangible operating assets over the past two years; and

  5. Reduced Risk Profile – as a result of both controllable (i.e. internal company specific) and uncontrollable (e.g. external market conditions) factors, both companies decreased their risk profile (i.e. lower discount rate or capitalization rate) thereby increasing the valuation multiple.
  6.  
Any increases in redundant assets owned by your business (e.g. non-operating assets such as excess cash or marketable securities) or decreases in interest bearing debt outstanding will increase the value of your equity interest over and above the increases to enterprise value noted above.
 
It may not be easy but concentrating on these 5 factors will go a long way towards helping you double your business’ enterprise value in a two year period.  If you are planning to exit your business in the coming five years now is the time to get focused.
 
An independent business valuation can help measure your value increases over time.  This becomes critical if you are planning to exit your business in the coming decade and want to maximize your net sale proceeds.  Contact us at jason@vspltd.ca or www.vspltd.ca to see if you qualify for our VSP Exit Starter Program or want to document your value increases over time with an independent business valuation.
 
 
1.  Enterprise value represents the value of business operations attributable to both equity and debt-holders.

Thursday, December 12, 2013

The Key to Timing the Sale of Your Business

When is the right time to sell your business?  This can be a difficult question to answer.

In Deciding to Sell Your Business by Ned Minor, Mr. Minor suggests that you should sell your business "at the point when you achieve your definition of financial independence."

I encourage business owners to consider timing from the perspective of: i) the business owner; ii) the business; and iii) the market.  In a perfect world, each of these will be in alignment when timing the sale of your business.  Let’s consider each in turn.
 
1.  The business owner - when will you be ready to sell? 
    To help answer this question, ask yourself if you still have the same level of energy and passion you once had for your business.  You should also address what you plan to do after you exit your business.  Only you will know when you are emotionally and psychologically ready to leave your business.

    Keep in mind that your age, energy level, passion, health and willingness to stay on after a sale can impact the value of your business.  In many cases, holding on too long can serve to reduce the value of your business.

    Ideally, you should sell just before the point in time when your passion and energy level for your business begin to wane.


2.  The business - when will your business be ready to sell?
    A proper plan is necessary to ensure that your business will be ready for sale when you are ready to exit and the successful implementation of this plan will take time - at least 3 years. 

    To ensure your business is ready for sale at its peak value you should assemble a pre-sale diligence binder that provides all information necessary to ensure a smooth sale process.  To maximize value, this binder should show, among other things, a track record of steady growth (i.e. for at least 3 years) and a business plan setting out how you will achieve continued growth.  Showing a buyer that there are high barriers for potential competitors because of your industry niche, competitive advantage or proprietary technology will go a long way towards commanding a premium price.

    Ideally, you should sell your business after a period of steady growth (i.e. at least 3 years) and just before a plateau.  This creates the allure of future growth which drives up value.


3.  The market – when will the market be ready for you to sell?
With proper planning, you can have some control over 1 and 2 above.  The market, however, is one thing you can’t control and its future is inherently uncertain and unpredictable.  Keeping up with the level of activity in your industry can help you time your sale.  Speak with others in your industry, read trade journals and industry publications, join an industry association, speak with valuators and M&A professionals to get sense as to how hot or cold the market is in your industry.
Markets can be volatile with high peaks and low valleys.  Ideally, you want to sell at a peak when demand and market multiples are high.  Clients often ask me how the markets are doing and where market multiples are compared to past years.  In Canada, there is limited information on private company transactions.  Looking to the U.S. as a proxy, however, and conducting a search of all transactions for companies with positive earnings reveals the following results over the past decade: [1]

 
Number of Transactions
EV / EBITDA Multiple
EV / Sales Multiple
Year
Harm. Mean [2]
Median
Harm. Mean [2]
Median
      
2004
701
3.85
5.54
0.43
0.57
2005
793
3.66
5.63
0.44
0.60
2006
725
4.40
5.94
0.45
0.65
2007
814
3.83
5.88
0.48
0.66
2008
483
4.49
6.16
0.45
0.67
2009
302
3.76
4.76
0.41
0.59
2010
354
3.60
5.70
0.49
0.66
2011
395
2.65
5.80
0.44
0.73
2012
744
2.20
2.92
0.37
0.52
2013
350
2.32
3.20
0.23
0.51


It is interesting to note that average EBITDA multiples have been declining since 2008 with the exception of a slight uptick in 2013.  Average sales multiples have also been trending down for the past four years and actually dropped below 0.4 times in 2012 and 2013 for the first time since pre-2004.  It is also interesting to note that market activity (i.e. total # of transactions) dropped off in 2008 and, with the exception of 2012, does not appear to have returned to pre-2008 levels.

Keep in mind that this data aggregates transactions from all industries and that results will vary depending on the industry in which you operate.

In light of this trend and the expected significant increase in the supply of businesses for sale over the coming decade (i.e. some 550,000 businesses in Canada), it will be that much more critical for business owners and their businesses to be prepared.  Only the most attractive and salable businesses (i.e. those that are prepared) will sell for a premium. Those that are not prepared risk selling for a significant discount or face liquidation altogether.
 
If this concerns you, our Exit Starter Program can help. To see if you qualify for our VSP Exit Starter Program, contact us at jason@vspltd.ca or www.vspltd.ca.


1.  Source: Pratt’s Stats private company database. 2013 figures up to October 25, 2013.
2.  The harmonic mean tends to mitigate the impact of large outliers and aggravate the impact of small ones.