Tracey McVicar is partner at CAI Capital Partners, a Vancouver-based private equity firm.
In Canada, almost three quarters of business owners plan to exit their company by 2028, putting more than $1.5-trillion of assets in play. And in the United States, sales of small businesses remain near record highs, despite trade and political concerns.
There is much to think about when it comes to this crucial juncture in the life of a company. There are many external factors business owners can’t control, such as the general economic or industry environment. However, we at CAI have found there exists a set of critical considerations owners should keep in mind when seeking to increase the value of their business – whether they’re looking to sell soon or not.
Improve your cash flow margin
In order to generate $5-million in cash flow, a company either needs $500-million of revenue at a 1-per-cent margin, or just $33 million at a 15-per-cent margin. To a potential buyer, the latter looks like a healthy business, probably with free cash on hand to expand further. The former could be just steps from disaster. It’s clear which is more attractive.
Owners also have to think about how much capital investment is required to sustain their business. A good rule is that you shouldn’t spend more than 20 per cent of EBITDA (earnings before interest, taxes, depreciation and amortization) on capital maintenance required to sustain operations.
Reduce customer concentration
Let’s say you sell office furniture and you’ve signed a great deal with a big retailer such as Costco or Walmart. The money is coming in, but suddenly, that retailer accounts for 40 per cent of your company’s revenue. It is very difficult for an outside buyer to get comfortable with that level of sales concentration, which would be reflected in any potential price they’re prepared to pay for your business.
It’s also risky to operate a business this way because the world changes quickly. If a recession hits tomorrow, your rock-solid retail deal could start to feel pretty shaky. It’s important to keep your customer base diversified.
Pursue Level 1 growth opportunities
This is your basic organic growth. Can your company do more of what it’s doing, profitably, and does it generate enough free cash flow to fund high single- or low double-digit revenue growth? Can your market sustain several years of this growth rate? All other things being equal, a bigger business is worth more money, regardless of when you sell.
Strong management, professionalized processes
You need a robust management team that can run the business today and in the future – especially if you plan to retire down the road. Buyers want to see a strong talent bench, ideally ready to succeed you if needed. There are many books and articles about building a great team and a positive, engaging culture – with good reason. These are key value drivers for any business.
Processes are less sexy, but just as important. Do all of your employees – and especially your leadership team – understand how the business runs and makes money on a daily basis, or is it all in your head as the founder? Do you use words such as “ballpark” or “roughly” when discussing forecasts or performance, or do you have a proper system in place that can give you reliable, real-time feedback?
Emphasize recurring revenue
This is music to the ears of both buyers and owners. After all, who doesn’t like money coming in on a regular basis? Companies that sign multiyear contracts with customers are more attractive to buyers than those who do not – it’s as simple as that. And the more creditworthy your customer, the better – think governments and utilities as a start.
Identify Level 2 growth opportunities
Last but not least, these tend to be growth opportunities that aren’t typically considered by owners and founders because they represent significant, higher-risk bets that fall outside their comfort zones.
These could include acquisitions of complementary businesses, or pushing into new markets or adjacent business lines, using both free cash flow and a reasonable amount of debt. This is not for the faint of heart and it really helps to have a board or other stakeholders around you when you’re executing on this type of strategy.
Think like a seller – even if you’re not ready for an exit – and you can create great value and growth opportunities for your business, your team and yourself.