In speaking to owners in the $3M - $10M range about selling their business, we discuss the concept of value vs profit. The distinction is important and takes a little bit of thought to get used to.

One of the first topics we discuss is profit. How much is the business making on an Earnings Before Income Taxes and Depreciation (EBITDA) basis or Seller’s Discretionary Earnings (SDE)? SDE represents the total financial benefit to the owner and includes salary, the business’ profit and benefits such as an automobile and health benefits.

We then talk about the value components. In some instances, owners say out loud “what the hell are you talking about? Isn’t the value of the business, the profit times some multiple you are going to share with me?” The answer is partially “yes”.

The value drivers relate to how the business is run, not just its profits. All things being equal, a well-run business is more valuable. Let’s talk about three areas and the impact on value:

Sales function

There are many components to sales, but let’s touch upon a few of them:

• Is there a sales process that the sales organization follows?
• Are there sales quotas that are well understood by the sale force?
• Do the sales quotas support the budget?
• Is there a process for hiring salespeople?

I usually hear “yes” to all these things. In follow up questions I ask why doesn’t the company have someone leading sales other than the owner? More than occasionally I here “we have had people over the years, but they did not work out.” Well naturally my question becomes “how can you have a working sales process, quotas, and an appropriate process for hiring a sales force and have not been able to hire someone to successfully run the sales force?” That is a rhetorical and gets to the point that there may not really be an operating sales function outside of the owner.

A company that has a sales force that is not reliant on the owner is a more valuable company.

Customer concentration

This is usually an issue if two or three accounts approach 50% of the company’s revenue. Owners usually push back on this being a problem. They feel that they should not turn down business with their current customers and that they are well entrenched with these customers which is why they are able to do so much business with them. The relationships with some of their customers are long standing.

All of this is true, but what if something changes at the customer’s company? What if the company is sold and a new owner does not have the same degree of loyalty? What if price becomes more of an issue reducing the profitability of servicing the customer? All of these things could happen which is why companies should consider diversifying their customer base so that the dependency is not so concentrated.

I was involved in selling a company recently. Years prior to my involvement the company had two large customers. Within a matter of months each of the customers independently terminated the relationship and took the function in house. It left the owner with excess payroll and a loss of revenue. Naturally in trying to sell the company the decline in revenue and profit was something that had to be explained and created a negative impression. The owner took a step back and decided to refocus the sales effort and become less reliant on large accounts. This change in strategy reflected positively in the financial statements over the next several years, but it took the owner that long to pivot and to be able to show how the company could be refocused and successful. The company did end up successfully selling but only after the impact of losing those major accounts was well in the rear-view mirror.

Another conversation I had with a former business owner at a 4th of July celebration. He was lamenting on the fact that his company went out of business. He said to me “my two largest customers went bankrupt, what was I supposed to do?” The answer would have been to monitor your customers and minimize your risk. However, being that we were at a picnic, I decided to stay away from the honest response and change the topic. After all his business had closed.

A company with little customer concentration is a more valuable company than a company with high customer concentration.

Financial statements

In discussions with owners, we naturally talk about the financial statements. After all that is what a buyer is buying – the cash flow of the business.

If it takes time to understand the financial statements, they are incomplete or the books are not closed regularly, you are asking a buyer to do too much work to understand the company.

My experience has been that buyers are pretty savvy and can understand financial statements that are well presented. If the buyer has to rely on forensic work from people he has to hire, he is less comfortable relying on the information he is seeing. That lack of comfort typically results in no interest in buying the company.

A company with good financial information that is used in running the business is more valuable than a company that does not run the business “through its numbers”.

These three instances of things that create value in a business are written from the perspective of a business that may be for sale. I have found that buying a business is largely a binary decision. The buyer looks at the business, industry, profitability and value drivers and decides whether or not it is good business to buy. If there is a lack of a sales function or poor financials, there may be some discounting on the price, but usually the buyer simply does not pursue buying the company. If there is a high degree of customer concentration there is no discounting, the answer is that there is likely no interest to acquire the company.

The reality is that these are value drivers you want to have in running a business during the time you own the business, not just as it is being prepared for sale. Getting a business ready for sale is little more than mastering the basics of creating a well-run transferrable business.