In
managing their company, business owners should not focus solely on the day-to-day operations, but should always consider the
long-term strategic impact of today's decisions on the future value of the company. Thus when analyzing any business decision,
one must consider issues beyond the scope of the company's immediate financial performance, and remain cognizant of the implications
the decision will have on the valuation of the company upon exiting.
Issues to Consider When Making Business
Decisions
Customer Concentration
Small to medium sized businesses ("SMBs") typically
derive the majority of their revenues from a limited number of customers. Although these customers generally comprise highly
profitable, long-standing relationships that are key to the success of the company, owners should not become complacent. The
loss of one of these key customers could financially cripple a company. Although owners should pay special attention and even
give preferential terms to retain their key customers, they should also proactively develop relationships with new customers.
Customer concentration often becomes a point of contention when valuing SMBs. Many acquirers, especially financial
buyers, shy away from companies that derive a majority of their revenues from a handful of select customers. The loss of one
of these important customers may result in the acquired company posting drastically lower revenue and profit figures. Due
to this risk, acquirers will generally apply valuation discounts to companies with a high degree of customer concentration.
Although some strategic acquirers may hold a company in a higher regard if it possesses a strong relationship with a particular
client, this is the exception rather than the rule.
Strong Partnerships Finding suppliers who can
serve as the "one-stop shop" solution for companies has grown in popularity over the years, however, companies should
still develop and maintain key strategic relationships with other suppliers involved in similar or complementary products
and/or services. Developing a broad partnership network may play an important role in the success of your company. For example,
the bidding process for a large contract may require skills and staff that your company does not possess. In this case, your
company's only chance to place a competitive bid would be to leverage your partnership network to assist in delivering the
project. Conversely, your industry partners may require your help on their projects, thus producing an inflow of business.
A partner network may be even more crucial during your exit process, as a partner could become your acquirer. There
are a number of reasons this scenario could occur. First, the relationship may be so crucial to a partner's operations that
they may fear that a change in ownership will result in a shift in your business focus and disrupt the nature of their relationship
with you. Second, partners providing similar product and/or services may be looking to expand. The acquisition of your company
could expedite increasing their customer base, capacity, and revenue growth. Lastly, partners with complementary products
or services may develop an interest in your company which could enable their in-house operations to service a larger percentage
of their customers' needs.
Develop A Strong Management Team / Successor Some business owners in the
SMB space control every aspect of their day-to-day operations. If the owner plans to exit the company, this autocratic structure
might become problematic. Although strategic acquirers should have no problems with this issue (because of their existing
industry skills), financial buyers may find this management structure to be problematic if the current owner's exit causes
paralysis at the company. Thus, a manager of equal or greater capabilities will need to be brought in to run the acquired
business. The executive search process will prolong the acquisition, and could potentially kill the deal.
The risk
in bringing in new management may be too great of a deterrent for financial buyers as the new managers will not have the same
breadth of knowledge of the company's specific market niche, geographic atmosphere, and current client relationships as the
previous owner. In order to avoid this problem, companies should develop some form of management team, so that all members
are capable of running the firm's operations.
Long-Term Real Estate Leases A long-term lease generally
presents advantageous financial terms over a short-term lease and locks a company into specific locale for a greater period
of time. Long-term leases are especially advantageous to a company if the property is situated in a location conducive to
business. Although these benefits usually lead companies to sign long-term leases, owners should be aware that a long-term
lease could have a negative impact upon valuation. Both strategic and financial buyers generally prefer to acquire companies
that do not have long-term leases and are easily relocatable, because:
- Acquirers who have operating units
in close geographic proximity may want to "tuck-in" the acquisition (meaning that the employees and equipment of
the acquired company are moved into the acquirer's facilities).
- Acquirers might want to use the acquired
company as a platform to expand into a new product, service, or geographic market. This agenda usually entails a plan to grow
the acquired company into a larger entity, and a larger facility would be required to accommodate growth.
Leases
that lock in an acquisition target for a substantial period of time can be a deal breaker, or at a minimum devalue your company.
If any of the two scenarios that are detailed in this paragraph occur, the company's current leases represent an unnecessary
post-acquisition expense to the potential acquirer. It must be noted that this commentary regarding real estate leases is
only applicable to companies which do not require to remain at the same locale to maintain current financial performance levels.
Diversity of Customer Base
Some companies cater to a particular industry. While this strategy
enables a company to specialize in products and/or services related to one industry, and gives them a competitive advantage
in winning contracts, it also forces the company to take on risk due to a lack of diversity. If the industry suffers a cyclical
downturn, the company specializing in the industry usually falters as their customers place fewer orders. Although unavoidable
in certain situations, companies should not specialize in serving just one industry. If a company believes in the merits of
industry specialization, it should attempt to diversify its product and service offerings to include another industry which
is counter cyclical to their other industry.
Companies specializing in work within a single industry represent an interesting
situation for an acquirer. Specialization may be valued at a premium by acquirers who also specialize in the same area, or
are looking to enter this market. However, more often than not, acquirers view the target company's products and/or service
offerings as limited and reduce the valuation appropriately.
Conclusion
This article has highlighted
some of the general issues that should be considered in maximizing the value of your company. These topics are in no way inclusive
of all factors that an acquirer will inspect; every transaction is unique and dozens of variables could be used to calculate
a company's value. Keeping these issues in mind can help owners to analyze how each decision they make today will affect their
business valuation in the future.
