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When it comes time to sell your business, will it command a value that is at the high end of the multiple range or closer to the low end. Often times, the answer will be determined based on how well you addressed the other value drivers that savvy buyers/investors look at when valuing a business. Most small and medium sized businesses operators focus the majority of their attention on improving financial performance. This is entirely understandable as profitability and cash flow are the primary KPI’s for many businesses. However, if you are looking to build maximum value in the business, you must broaden the focus to address a wider range of value drivers.  In recent years, undertaking a “sell side” Quality of Earnings study has become a popular exercise to help companies prepare for an effective sales process. While this is helpful, it really does not go far enough if you want to optimize the results. That requires a more comprehensive exercise that takes a deep look at all of the key value drivers. At Value Acceleration Partners, we call it a Quality of Value Audit. So, what are these value drivers. In my experience, there are at least eight: Let’s take a look at each one of the drivers individually. Driver #1 – Company Culture Let’s start with perhaps the most basic issue of all, your company’s culture.  This refers to the values, beliefs and behaviors that determine how your company’s employees and management interact, perform and handle business transactions. This area is often grossly under-appreciated or ignored. Even the companies that profess to focus on it often just go through a highly visible exercise to define it and then basically put it in a drawer and it is soon forgotten. Building a durable company culture that significantly impacts performance requires a day in and day out commitment. It is hard, but worth it! Objective An easily explained set of core values that are used to govern decision-making and behavior, as well as defined themes that are easily explained, understood and embodied by management. Key Questions Where The Answer Should Be “Yes” Driver #2 – Management Breadth In the eyes of a potential buyer, one of the biggest risk factors and potential value killers is the degree to which the business in dependent on the principal. In extreme cases, this factor alone can make an otherwise profitable and successful business virtually unsellable. Often a business owner/operator takes great pride in the fact that he/she knows every customer personally and they turn to him/her on issues. In reality, this means that the company is deeply dependent on you as the Rainmaker for the business and that creates significant risk. Objective A management team that is clearly demonstrating the ability to effectively direct all key areas of the business without deep involvement of the principal(s). In addition, it important to have an appropriate long term incentive plan designed to retain the key managers for the long term.  Key Questions Where the Answer Should Be “Yes” Driver #3 – Value Proposition Durability Creating true differentiation in the products and benefits your company delivers to its customers is a critical component of building value in your business. This is especially important in the eyes of your prospective buyer. Warren Buffet, arguably one of the great buyers of businesses of all time, points to the presence of a true “competitive moat” as a key issue that he looks at when evaluating a company. While not easy to achieve in many industries, it is possible, and figuring it out offers great benefits: Even companies that sell commoditized products have the ability to build a moat by wrapping valuable services around it. Your product does not just have to be the physical unit. Objective You want/need a value proposition that provides a strong “moat”, barriers to entry, a recurring revenue stream and long term sustainability. Key Questions Where The Answer Should Be “Yes” Driver #4 – Recurring Revenue Model Perhaps the biggest driver of positive value on a business is the degree to which the business model provides recurring revenue. In fact, a strong recurring revenue model can mitigate the many of the other risk factors. A recurring revenue model offers several important benefits: The type of recurring revenue also makes a difference. For instance, recurring revenue that comes from selling a consumable is not as valuable as selling a subscription. Having guaranteed contracts is even better. The bottom line…companies with recurring revenue business models are valued at a meaningfully higher multiple than those without such models. Objective A business model that provides for meaningful recurring revenue that can sustain above average growth that can be accurately projected. Key Questions Where The Answer Should Be “Yes” Driver #5 – Operational Scalability Operational scalability is your business’s ability to scale its organization, business model or system to cope with significantly increased demand for your products and services.   While your brand’s strength, value proposition, management depth, etc. are important in assessing a business, ultimately, a buyer is investing in future cash flow. And that is largely driven by the growth potential of the revenue stream and the margins that will be generated from it. Bigger revenue streams generally command higher earnings multiples in a sale. So, it is important to think deeply about the real growth opportunities in your business. Often times this means taking a step back in order to take multiple steps forward. It is hard to give up the revenue from a product or service line but sometimes that is exactly what is needed to accelerate growth. The ability to operationally scale, and to do so at improving margins, is a critical part of the equation. Your company has to be ready to scale and this can be challenging. The landscape is littered with companies that outgrew their capability to absorb the growth, usually due to poor planning. Strong top line growth, combined with strong processes, combined with improving margins is the holy grail of maximizing value in your business. Objective Your business should offer a demonstrably scalable operating environment that includes well defined and well documented processes that can be relatively easily scaled as well as effective processes for onboarding/training the personnel required to scale

Stagnation is a business killer. To ensure sustainable growth, you must continually assess and refine your processes. If it ain’t broke, make it better! Keeping the same strategies simply because they are familiar, and work reasonably well, really limits the potential for greater success.  To ensure your organization’s longevity, leaders should make a habit of questioning why processes are done certain ways. Examining and improving productivity is key to maximizing margins while avoiding blanket cost-cutting strategies that could put the company in jeopardy. By constantly asking ‘why’ you can identify and fix costly bottlenecks and inefficiencies.  Many businesses are usually under intense pressure to reduce costs, often starting with headcount. However, cutting workforce without redesigning processes can be the start of a vicious cycle that only speeds up an organization’s demise. Reducing expenses by laying off employees may reduce overhead initially; however, this leaves remaining staff with more work while eventually jeopardizing quality control. With a shrinking labor pool, it is important to look to increase efficiency first. Failing to update workflows and processes can cause frustration among employees, leading to low morale – even prompting turnover in an already tight market. To avoid this detrimental cycle it is essential to take the time to reevaluate standards of work; ask questions about why things are done the way they are and identify ways that make operations simpler yet more effective. Of course, all of this is easier said than done. Re-engineering processes effectively requires specific expertise. Look internally or externally for people that have the Six Sigma or Lean Manufacturing experience that is needed to map out every nook and cranny of an organization, uncovering areas where improvement can be made – from streamlining existing operations to identifying tasks which no longer add value. This type of process mapping can be painstaking but it is critical to the improvement process. It is hard to identify improvement opportunities until the team has a clear view and consensus of how things are currently done. Investing in process improvement is essential for any business striving to create an environment conducive to growth. You can easily reap the rewards of these improvements through several different options – from outsourcing consultants who specialize in mapping and streamlining processes, hiring staff dedicated for this purpose or tasking existing employees with managing and optimizing operations. No matter which strategy you choose there are no risks associated with pursuing progressive solutions that will help your organization succeed!

Asset Sales When it comes to selling a company, it is critical for buyers and sellers alike to understand the distinction between asset and stock transactions. In an asset sale, the seller relinquishes ownership of their assets while remaining the legal owner of the business.  In contrast, in a stock transaction they are selling equity in the organization. Both options come with advantages and disadvantages that should be weighed according to each situation’s unique needs – helping maximize returns on both sides of the negotiation. An asset sale can present an advantageous opportunity for buyers: they can acquire individual assets and liabilities at fair market value, with the tax basis stepping up from original investment.  Additionally, purchasers have full discretion to determine which liabilities are assumed versus left behind with seller.  By limiting potential unknown liabilities, the buyer can spend their time, money and resources more efficiently which usually results in a faster, lower cost transaction. An asset sale may not be the ideal solution for everyone, as it can lead to a double taxation on sellers if their assets have appreciated in value. This resulting cost of transferring ownership means that buyers and sellers must work together to ensure any contracts with customers/suppliers are renegotiated accordingly. In turn, this could result in higher purchase prices from buyers. When an asset sale takes place, the seller needs to make sure all assets purchased are liquidated and liabilities settled. Additionally, unlike a stock sale, minority shareholders who refuse to sell their shares can be forced into accepting the terms of this type of transaction. Lastly, with respect to securities laws and regulations – usually no compliance is required from either buyer or seller which makes it simpler than other alternatives available in corporate finance transactions. Stock Sales A stock sale allows for seamless, quick transfer of ownership and cash to the seller’s shareholders. This type of acquisition involves minimal negotiation beyond that which is already agreed upon in terms set forth by both buyer and sellers – making it a popular choice among those wishing to complete a transaction quickly. The benefits are significant; less red tape gets transferred assets into the hands of buyers faster while allowing them to bypass costly taxes often associated with such transactions. When acquiring stock, buyers can’t get the full benefit of a step-up in tax basis. That’s because they don’t own legal ownership to the acquired assets and must take on all liabilities.  This is no way to pick or choose which liabilities stay. If there are liabilities that the buyer is not willing to assume, one option is to execute separate agreements that give them back to sellers. One potential complication in a stock sale is that shareholders have the option to hold on to their shares, which can unfortunately prolong transactions and result in substantial added costs. Additionally, when dealing with a large number of shareholders securities laws must be adhered to in order for an acquisition to proceed; this further complicates matters as it also increases risk due unforeseen uncertainties presented by the sale. Purchasing an LLC, sole proprietorship or partnership can’t be done through a stock transaction; however, their owners are able to sell interests like partnerships and memberships instead of the company’s assets. With multiple deal options available, it is crucial to find the right one that best fits your needs. To ensure optimal outcomes and minimize potential risks, enlisting professional M&A experts can be an invaluable asset.  They possess in-depth knowledge on these transactions with proven results for reaching successful agreements. This can be costly but is usually worth it.

The increase in interest rates over the past year is wreaking havoc on business valuations and the ability to get deals done.   So, if you are a potential seller of a business over the next few years, it is more important than ever to take the steps necessary to optimize enterprise value.  Failure to do so will likely result in a very disappointing outcome. The biggest way that rising interest rates impact company valuations is through their effect on discounted cash flow models. These models are a popular valuation tool used by investors to determine the intrinsic value of a business. They use a company’s projected cash flows and discounts back to present value, using a discount rate to account for the time value of money. As interest rates increase, the discount rate used in these models also increases, leading to lower present values and reduced company valuations. Another big factor is the impact of rising interest rates on the cost of capital for companies. The cost of capital is the required rate of return that lenders and investors demand in exchange for providing capital to fund a transaction.  As interest rates increase, the cost of capital also increases, making it more expensive for companies to raise capital through equity and debt financing. This makes it more difficult for an acquirer to hit their target return on investment which, ultimately, leads to a lower valuation and offer for the business. Finally, another and more indirect way that rising interest rates impact company valuations is through their effect on consumer sentiment. As interest rates rise, consumers may have less disposable income to spend, leading to lower demand for goods and services. This can impact the outlook for revenues and profits, leading to lower valuations. In light of the potential impact of rising interest rates on company valuations, businesses that plan to sell in the next few years need to focus on getting ready now. This means taking the obvious steps to improve financial performance, strengthen their balance sheet, and reduce their reliance on external financing.  However, it really goes beyond make sure the financial house is in order.  These businesses should explore ways to strengthen their value proposition, diversify revenue streams and reduce reliance on key personnel, clients and suppliers.  These are all factors that can either enhance or kill value in a business. In summary, rising interest rates can have a significant impact on company valuations, leading to shrinking valuations and reduced investor interest. It is more important than ever to make sure your business is positioned to command an EBITDA multiple on the high end of the range, rather than the low end. To gain insight into where your company scores and compares on the eight key factors that impact the value of a business, click here.

In today’s highly competitive business environment, understanding customer and employee satisfaction is crucial to the success. One very popular method of measuring satisfaction is through the use of the Net Promoter Score (NPS), a metric that has become increasingly utilized since its inception in 2003. In this post, I will discuss the history, methodology, and effectiveness of the Net Promoter Score, as well as how companies can use it to keep their finger on the pulse of their clients and employees. History: The Net Promoter Score was introduced by Fred Reichheld, a partner at Bain & Company, in an article published in the Harvard Business Review in 2003. The idea behind the NPS was to provide a simple, yet effective way of measuring customer loyalty and satisfaction. Reichheld believed that by asking a single question, “How likely is it that you would recommend our company/product/service to a friend or colleague?” on a scale of 0-10, companies could identify their most loyal customers and improve their overall customer satisfaction. Methodology: The NPS is calculated by subtracting the percentage of detractors (customers who respond with a score of 0-6) from the percentage of promoters (customers who respond with a score of 9-10). The resulting score ranges from -100 to +100, with a higher score indicating a higher level of customer loyalty and satisfaction. Effectiveness: Reichheld found that the results from this one simple question was actually more predictive of future growth than longer, more complex surveys.  It has been shown to be effective in predicting customer behavior, such as whether a customer will make a repeat purchase, refer friends and family, or leave a negative review. The simplicity of the NPS also makes it easy for companies to repeat the survey and to track changes in customer satisfaction over time and make improvements accordingly. Additionally, because the NPS is based on a single question, response rates tend to be higher than with longer, more detailed surveys. Not Just For Customers: In addition to measuring customer loyalty and satisfaction, companies can also use the NPS to gauge employee satisfaction and loyalty. By asking employees the same question, companies can identify areas for improvement and take steps to improve employee satisfaction, which can in turn improve customer satisfaction. In this way, the NPS can be used as a tool to keep a finger on the pulse of both clients and employees. The NPS has become an indispensable tool for companies looking to consistently measure customer and employee loyalty and satisfaction levels. In today’s highly competitive environments, you really cannot afford not to stay very close to what your customers and employees are thinking.

You know gross margin impacts your profit, but have you considered the impact it has on the value of your company? When assessing your company’s value, acquirers and investors will often scrutinize your gross profit margin. As you likely already know, gross profit margin is the difference between a company’s revenue and its cost of goods sold (COGS). While the Cost of Goods Sold (COGS) calculation does not typically include general operating expenses, it should include direct labor expense associated with producing and delivering the product or service.  A lot of businesses don’t do a particularly good job in allocating labor properly and this can come back to haunt them when they go to sell.  Often times an acquirer will attempt to go back and make these adjustments themselves to gain a better understanding of profitability.  If significant adjustments are called for, it will almost always negatively impact their determination of value. A high gross profit margin is a crucial factor for investors and potential acquirers as it can indicate that a company has established pricing power through marketing differentiation and possesses a competitive advantage and a strong competitive moat is an indicator of a company’s long-term sustainability.  In addition to providing indication of pricing power, an improving gross margin trend gives insight into the degree of operating margin that exists in the business.  Attractive operating leverage often exists in manufacturing businesses that have significant excess capacity. Conversely, when a company’s gross margin shrinks, it indicates to investors that the company may be competing on price. This is typically a sign that the business lacks a unique value proposition or marketing differentiation and that competing on price is the only way to attract customers. 24 vs. 6 Times Earnings To illustrate the impact of gross margin on a company’s value, let’s compare two companies: Apple and Dell. Apple has a strong competitive advantage and a healthy gross margin, whereas Dell’s competitive moat is weaker and its gross margin is lower. In 2022 Apple’s average gross margin was 43%, compared to just 23% for Dell. Apple has a highly differentiated brand and controls the buying experience through its Apple Stores. Additionally, Apple has invested in a range of high-margin subscription offerings, such as Apple TV and Apple Music. The market is willing to pay more than 24 times Apple’s 2023 earnings forecast, and the company has a market capitalization of over $2 trillion. By contrast, Dell offers commoditized technology products, which puts them in a weaker competitive position, requiring them to compete on price and resulting in a lower gross margin. The market is only paying around six times Dell’s 2023 earnings estimates, giving it a total market capitalization of around $30 billion. Just as gross margin impacts the world’s largest publicly traded companies, it also impacts smaller businesses. Ron Holt started Two Maids & a Mop, a residential cleaning company, in 2003. Holt ran a lean business and enjoyed healthy gross margins and a net profit margin of around 30%. Holt invested his earnings in differentiating his business from mom-and-pop cleaning services. He built a network of 12 locations across the southern U.S. and had plans to expand across the country. Holt was curious about franchising as a business model and attended a Las Vegas conference where he had a chance encounter with Subway founder Fred DeLuca. Subway had more than 40,000 locations around the world at the time, so Holt asked DeLuca for his expansion advice. Armed with DeLuca’s advice, Holt grew Two Maids & a Mop from 12 to 91 locations and $40 million in revenue without seriously compromising his gross margin. In 2021 Holt sold his business to JM Family Enterprises for over ten times EBITDA. Taking Action Apart from raising prices or reducing input costs, an often overlooked approach to improving gross margin is to invest in carving out a point of differentiation for your business in the minds of your customers. When your customers see your business as unique, you are less likely to have to compete solely on price. Charge a premium for a differentiated product or service, and you’ll beef up your gross profit margin—and the value of your company.

There are many factors, beyond pure financial performance, that impact the salability and value of a business. Some factors have a bigger impact than others. Perhaps none is bigger than the presence of recurring revenue in the business model.  Developing recurring revenue is crucial because it helps in stabilizing cash flow, creating customer loyalty, and improves the predictability of growth. All of these give prospective buyers confidence which should translate into a higher valuation. Here are six ways to that can tweak your business model to provide a recurring revenue stream in your business: A Great Example – HP Instant Ink For an example of an organization that turned reoccurring sales into recurring revenue, let’s look at the “HP Instant Ink” program. HP had been in the business of selling printers for decades before launching their toner replacement subscription.  HP would sell you a printer in the old days and hope you would come back and buy your toner cartridges from HP. As cheaper replacement options became available, HP started to lose reoccurring revenue from people who owned HP printers but chose a more affordable alternative to refill their cartridge.  In response, they launched the HP Instant Ink program to solve this problem by offering a toner subscription. HP sends subscribers new toner for their printer each month. You can sign up for a plan based on how many pages you print. If you exceed your page allotment one month, you can top up your account. If you fall short, HP offers to carry over your unused pages. Pricing plans start at $0.99 per month.  How does HP ensure you never run out of toner? They have embedded a reader in their printer’s hardware that sends a message to HP fulfillment when your cartridge dips below a predetermined threshold. Hence, you never run out.  It’s a brilliant little program and gives HP some recurring revenue while driving loyalty to HP printers. Repeat customers are the lifeblood of any business. If you want to jack up your company’s value, consider ripping a page from HP’s playbook, and turn your reoccurring customers into subscribers. 

Total Addressable Market (TAM) and Target Market are two very useful principles when it come to plotting strategy and you may be tempted to use them interchangeably.  However, while TAM and target market are related, there are fundamental differences.  Treating them as synonyms may be a mistake.   Let’s take a look at the differences.   TAM is an estimate of the total size of the market for your product or service over the long term. For example, if you sell left-handed spatulas, your TAM would be anyone who is left-handed.   Your target market is the segment of the TAM that you plan to focus on in the short to medium term.  Using the left-handed spatula example, you may decide to launch your utensil to restaurants, so you decide to target professional chefs who happen to be left-handed – a subsegment within your TAM.    One of the keys to developing an effective marketing plan is to pick a target market within your TAM that is large enough to meet your medium-term sales goals (i.e., the next year or two), but not so large that your messaging will become diluted.   How Avail Confused its TAM with their Target Market  In 2012, Ryan Coon started Avail, a software application designed to help landlords manage and communicate with their tenants more effectively.   Avail defined its TAM as landlords in the United States and Coon started marketing to all of them. Large commercial landlords have different requirements than small real estate investors, but Coon was treating them all the same. By 2016, the company had grown to $1 million in revenue, but Avail was experiencing churn, causing their growth to plateau.   Determined to get the company back on a growth track, Coon transformed his strategy. He niched down to his primary target market. A sub-segment of Avail’s TAM they defined as “DIY landlords managing less than ten units”.   Choosing a segment of their TAM helped Coon turn the company around. Narrowing their focus allowed the product team to simplify their features for amateur landlords. With a purpose-built product for smaller real estate investors, retention improved. The tighter definition of their market also led to better messaging that resonated with their target leading to improved response rates.   Between 2016 and 2020, Avail’s revenue grew from $1 million to $7 million. That’s when their expansion caught the attention of Realtor.com, who acquired Avail for around five times revenue.   Why Your TAM is Still Important  You may be wondering why your TAM still matters if the secret to better marketing is narrowing your target to a segment within it. However, your TAM remains important as you talk to investors or potential acquirers. Acquirers and investors place a premium on growth, so they are going to want to understand the total size of the market that is available for your product, even though you may have no intention of targeting them in the short to medium term.   Your TAM is important to the long-term value of your company, but tightening your target market in the short term, may be the key to meeting your goals for the coming year. 

If you have resolved to make your company more valuable in 2023, you may want to think hard about how your customers pay.  If you have a transaction business model where customers pay once for what they buy, expect your company’s value to be a single-digit multiple of your Earnings Before Interest Taxes, Depreciation and Amortization (EBITDA).   If you have a recurring revenue model, by contrast, where customers subscribe and pay on an ongoing basis, you can expect your valuation to be a multiple of your revenue.  Buyers pay a pretty penny for companies with recurring revenue because they can clearly see stability in revenue and cash flow.  Not sure how to create recurring revenue? Here are four models to consider:  Products That Run Out  If you have a product that people run out of, consider offering it on subscription basis. Many companies have re-engineered their business models to introduce this strategy.  For instance   retailing giant Target sells subscriptions to diapers for busy parents who don’t have the time (or interest) in running to the store to re-stock on Pampers. Dollar Shave Club, which was acquired by Unilever in 2016 for five times revenue, sells razor blades on subscription. The Honest Company sells dish detergent and safe household cleaning products to environmentally conscious consumers and more than 80% of their sales come from subscriptions.    Membership Model  If you’re a consultant and offer specialized advice, consider whether customers might pay access to a premium membership where you offer your know-how to subscribers only. Today there are membership websites for people who want to know about anything from Search Engine Marketing to running a restaurant.   Services Contracts/Monthly Retainers  If you bill by the hour or the project, consider moving to a fixed monthly fee for your service. That’s what the marketing agency GoBrandGo! did to steady cash flow and create a more predictable service business.  Piggyback Services  Ask yourself what your “one-off” customers buy after they buy what you sell. For example, if you make a company a new website, chances are they are going to need somewhere to host their site. While your initial website design may be a one-off service, you could offer to host it for your customer on subscription. If you offer interior design, chances are your customers are going to want to keep their home looking like the day you presented your design, so they might be in the market for a regular cleaning service.   Rentals  If you offer something expensive that customers only need occasionally, consider renting access to it for those who subscribe. ZipCar subscribers can have access to a car when they need it without forking over the cash to buy a hunk of steel. Co-working subscribers have access to office space without buying a building or committing to a long-term lease.  You don’t have to be a software company to create customers who pay you automatically each month. There is simply no faster way to improve the value of your business this year than to add some recurring revenue.  Of course, any major change to your business model must be made very carefully.  Test it carefully and only introduce it on a widespread basis when you are confident of the customer receptivity. 

In 2012, Jaclyn Johnson founded Create & Cultivate, a media company that educates and inspires women to succeed in business. By 2018, Johnson had grown Create & Cultivate to eight employees when an acquirer offered her a staggering $40 million. Unfortunately, the deal was too good to be true. When the acquirer discovered how dependent the business was on Johnson to succeed, they pulled out. A few years later, Johnson signed an acquisition offer from Corridor Capital for $22 million. While still a lucrative deal, it was a significant decrease from the original offer. Like Johnson, if your company becomes dependent on you, it may end up costing you down the road. The most valuable companies don’t rely on the owner’s involvement to succeed. However, finding extraordinary talent to replace yourself can be challenging.The Biggest Mistake Most Founders Make When Trying to Replace Themselves Finding a general manager, second-in-command, or Chief Operating Officer to replace themselves is one of the hardest projects founders may ever tackle. Whether you rely on a recruiter, paid advertising, or your personal network to find candidates, one of the first steps to shortlisting talent is a comprehensive review of their background. That’s when many founders make the common error of being bamboozled by a Fortune 500 name on a resume or LinkedIn profile. While a stint at a big company may be impressive, the skills held in high regard at a Fortune 500 company tend to differ from what most young companies need. Big companies often have well-established processes, systems, and hierarchies that have contributed to their success. People that thrive in big companies tend to excel at winning within a predetermined framework. However, in a younger, scrappier start-up, there is no framework to follow, which is why big company veterans often struggle in a more entrepreneurial environment. Instead of basing your hires off an impressive name on a resume, look for someone innovative, comfortable with chaos, action oriented, and creative—someone with an entrepreneurial mindset. Here are five strategies you can use to identify innovative candidates when making hiring decisions: With all of the above, you are looking for specific past behaviors and experiences.  To really gain the necessary insights, it is critical that you push for specific examples. Right now, your company probably relies on you for a healthy dose of creativity and innovation. But if your goal is to replace yourself, following these five strategies can increase your chances of identifying innovative candidates that will bring fresh thinking and creativity to your organization. Even if you have no short or intermediate term plans to replace yourself, have a strong number two in your organization will reap a lot of other benefits.