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Capital Ideas for Private Business

Look Beyond Cash Flow to Build Value

Five Value Drivers

By Jay Carter , Principal
Charlotte Office, Corporate Finance Associates

coverIn a strong economy, a company's cash flow is generally the most important component of the valuation equation for a Buyer. Buyers look at historical cash flow first – and then consider other valuation factors. Business owners understand this and strive to realize steady cash flow growth year after year. Unfortunately, most owners have recently discovered how difficult it is to continue building value by increasing cash flow in a global economic recession. In this environment, both sellers and buyers must look beyond cash flow when assessing a company's true valuation.

The current economic environment provides business owners a unique opportunity to identify and work on new valuation metrics that will enhance business value. These Value Drivers are characteristics of a company that buyers look for when deciding what company to buy and how much to pay for it. Value Drivers differ from one industry to another, but here are five that are universal and can enhance value in any business.

Value Driver 1

A management succession plan. Most closely-held business owners have not adequately planned for the unplanned death or disability of themselves, or of one of their key managers. Because much of the value a buyer is seeking when acquiring a company is the future cash flow of the business, an inadequate management succession plan can be devastating to the business, its employees, and owners.

Planning Tip: Imagine that you get up from your desk right now, walk out the door, and leave for a 30 day vacation. While away, you will have no communications with your company. What will fall through the cracks while you are away? What will get messed up? You have now begun your management succession planning process. Consider hiring an HR consultant to further help you identify where the gaps are and how to address them. Your corporate attorney will help you document your plans so there is no question as to your intentions, should you be unavailable to communicate them yourself.

Value Driver 2

Operating systems that improve sustainability of cash flows. A period of slow or no growth is an excellent time to take a look at your company's operating systems. While you're not too busy trying to get product out the door, look for opportunities to improve internal processes and create operating efficiencies. You may uncover opportunities to save money now and prepare the company for future growth.

Planning Tip: Provide opportunities for your employees to obtain special training, education, licensing or certifications that will enable them to be better employees.

Value Driver 3

A solid, diversified customer base. Customer concentration is one of the biggest value detractors of all for middle-market companies. It presents an element of risk that any buyer would like to avoid when possible, and if they are willing to assume this risk, they are normally well compensated for it in the form of a lower purchase price. When the overall economy is weak, it is especially important to stay on top of your customers and to know what is going on in their businesses.

Planning Tip: Visit your top five customers during the next month, with the specific purpose of listening to the challenges they are facing in today's economy, and assess how your business may be impacted. This may save you some immediate grief by avoiding a potential bad debt. From a longer-term perspective, devise and implement a plan to diversify your customer base. This may be possible through targeted organic growth or with a strategic acquisition.

Value Driver 4

A realistic growth strategy. Even in a tough economy, a clearly defined plan for achieving long term growth is critical to a company's valuation. When selling a company on the heels of a year or two of sub-par earnings and cash flow, it is the future that must be sold in order to maximize value.

Planning Tip 4: Challenge your sales people to think out of the box and develop new ways to increase sales. A sales coach may help facilitate a brainstorming session. Take the best ideas, incorporate them into a formal growth plan, and implement it. You may also consider buying a weaker competitor, or hiring away a top sales person.

Value Driver 5

Effective cost controls. Now more than ever, it is important that you look closely at all of your expenses and seize opportunities to eliminate or reduce them when possible. This is good cash management, and helps foster a new paradigm of thrift for your employees.

Planning Tip: Sponsor a contest among all of your employees. Ask them for ideas for cutting costs and reward those who contribute the best ideas. An added benefit is that your employees will appreciate the opportunity to be part of the solution.

There are numerous ways to grow the value of a business, even at a time when the business itself is not growing. The effects of the current worldwide economic recession will be felt for many months (and perhaps years) after it has officially ended. The silver lining is that for business owners who begin now, there is plenty of time to identify and implement value drivers that will have lasting impact on both the value and the salability of the business.

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